When an economy or industry is in trouble, it makes sense for lenders to show a bit of forbearance. In practice this means debt restructuring, which has a clear benefit for banks: they can present a picture of themselves more healthy than reality. The regulator will implicitly endorse this de facto deception, so long as its rules are followed. But this cannot go on forever. The global financial crisis of 2008 had prompted the Reserve Bank of India to ease both norms for restructuring and the way the institutions present their own accounts. But the Indian economy isn’t looking up, and growth is slowing further. Equally worrying is the realisation that the health of the country’s financial institutions may be far worse than it appears. The institutions’ own data, when studied carefully, reveal the problems. Currently the value of restructured assets exceeds the value of gross non-performing assets of the banking sector. Gross NPAs would more than double if the reclassification benefits or restructuring (being able to call a non-performing loan a standard asset) were denied.
Fortunately, the RBI is considering reform. An internal panel has recommended the withdrawal of asset reclassifications and provisioning benefits that banks can derive from restructuring of loans. This can be done, say, over a period of two years, given the toughness of the times. The panel recommends, too, increasing the provisioning of capital for the existing stock of restructured assets. Converting a firm’s debt into equity or preference shares, another element of restructuring, should be done only as a last resort, the panel argues, and that too within a cap of 10 per cent of the total restructured debt. This is important: banks should not get into owning equity in the industries risky enough to feature more companies that need restructuring. The promoter-friendly nature of the process also needs correction; they should also have to fork out more, bring in more capital, to avail of the debt restructuring process. Perhaps, most significantly, their personal guarantees should be made mandatory and not waived when the economy and the industry are hit by “external factors”, as deciding what is external can become subjective. In cases where a bank sees there is no chance of a restructured loan becoming healthy again, exit should be encouraged.
Some may argue that this is the worst time to tighten norms. A string of banks coming out with adverse results as a result of higher provisioning (taken out of the profit and loss account) would add to the markets’ gloom. That is an insufficient argument. It is always better to know how unhealthy the bank is, and the doctor withholding bad news serves no ultimate purpose. It perpetuates bad behaviour, and makes recapitalisation inevitable — and more expensive. Higher provisioning means less resources available for payouts, and that can only bolster a bank’s financial health. There is no question that corporate debt restructuring, as it stands now, encourages corruption and favour-seeking. Politically connected businessmen receive favourable and quick terms on their non-performing loans easily. Through the process, banks and depositors invariably lose. This drain needs to be plugged immediately.