How a bad loan farce gets another rerun after U-turn in RBI's philosophy

A new year, a new central bank governor. Yet the first salvo to come out of the Reserve Bank of India’s policy arsenal in 2019 is an encouragement of good old “extend and pretend” lending.

Banks and shadow banks are being allowed a one-time restructuring of loans of up to 250 million rupees ($3.6 million) to micro, small and medium enterprises that were in default on January 1, without having to mark them as nonperforming, the RBI said on Tuesday. Lenders are being given an extension of 15 months (up to March 31, 2020) to pretend that these stressed loans are standard. All they have to do is to make an additional 5 per cent loss provisions. By contrast, a secured loan classified as nonperforming attracts immediate provisioning of 15 per cent, rising progressively to 40 per cent – even 100 per cent – as recovery became increasingly doubtful.

Classifying restructured loans as nonperforming is a standard prudential requirement. India relaxed the norm in 2001 to encourage banks to clean up an overhang of corporate debt that had piled up in the exuberant first decade of the country’s economic liberalization. The solution back then lay in encouraging lenders to send problem loans to so-called Corporate Debt Restructuring, or CDR, an out-of-of-court mechanism that helped banks recover some money in the absence of a modern bankruptcy law. Lenders could keep loans referred to the CDR as standard on the books, meaning they didn’t have to make steep provisions for losses. 

However, the temporary palliative became a perennial crutch. When dealing with the aftermath of a different credit cycle in May 2013, it became clear to the RBI that banks were using the restructuring fig leaf to hide bad loans. To end the abuse, the RBI said it would scrap the asset-classification forbearance by April 1, 2015.

Even before that day arrived, there was enormous lobbying by banks at the behest of powerful corporate borrowers. India then was ranked 136th in the world for resolving insolvency; a modern bankruptcy law was still more than a year away. So RBI Governor Raghuram Rajan relented and gave lenders new tools – Strategic Debt Restructuring, or SDR, and (a year later) Scheme for Sustainable Structuring of Stressed Assets, or S4A – to avoid making provisions. 

It wasn’t a free lunch. Rajan also began an asset-quality review in 2015, forcing banks to step up disclosure of bad debt. The stick annoyed errant debtors more than the restructuring carrot pleased them. Rajan had to leave after just a single three-year term. But his successor Urjit Patel continued to tighten the screws. Now that there finally was a functioning bankruptcy law, Patel scrapped all the halfway houses – CDR, SDR and S4A – in February last year. Relaxed norms for asset classification and loan-loss provisioning also went away.

That shock therapy made corporate lobbyists more livid. Facing an all-round assault on the central bank’s capacity for independent action, Patel abruptly left last month before completing his tenure. The new RBI Governor Shaktikanta Das has begun his term by bringing back forbearance in a small but significant way. It’s small because India’s 101 trillion rupee credit market is overwhelmingly skewed toward large borrowers. Non-farm business loans of less than 250 million rupees account for only 22 percent of the pie; remove individual borrowers, and the share shrinks to 13 percent. 

Yet it’s a significant step politically. Small business loans have been under elevated stress since Prime Minister Narendra Modi’s disastrous November 2016 move to outlaw 86 percent of the country’s cash, a policy blunder followed up by a goods and services tax that raised compliance costs for a large number of tiny firms. The nonperforming asset ratio for the larger of the MSME borrowers – ticket size between 100 million and 250 million rupees – was 14.5 percent in June, up from 12.8 percent two years ago.

The banks don't want this pile to grow any further. That much is obvious. It’s also clear that the Modi government wants to ease the tax compliance burden on small businesses ahead of general elections that will be held by May. However, it’s not the job of the banking regulator to join the government as a sentiment booster.

N.S. Vishwanathan, an RBI deputy governor, said last April that “shorn of all forbearances” India’s new regulatory framework for stressed assets was finally on par with international norms, and that giving up on it would amount to “letting go waste” India’s landmark bankruptcy regulation.

That’s the risk now. Small business owners – as well as distressed farmers – have clout only before elections; billionaires wield their power indefinitely. Getting politicians to promise farm-debt waivers and 59-minute SME loans is easy. But now that the RBI has started flip-flopping, it’ll become that much easier for the tycoons to rewind the credit culture – back to the debtor-friendly show it always was.  

Andy Mukherjee is a Bloomberg Opinion columnist covering industrial companies and financial services.