How the next govt can put banking and financial sector back on track

This June is going to be a punishing month for the next finance minister. The country’s financial market is choked: The slow pace in the resolution of dud-loans, the contagion from the blowout at the Infrastructure Leasing & Financial Services (IL&FS), and a liquidity bind threaten vast swathes — from non-banking finance companies (NBFCs), mutual funds to realty firms — and all those caught in-between and around them. The liquidity slosh in the post-demonetisation phase has run its course; and the excesses during the period is partly the reason for the curse which is upon us now. With just a moon-phase to go before the reset in the finance minister’s office, the big question is: What’s the extent of grease needed from here on.

The dud-loan pile-up

The average resolution timeline for cases under the Insolvency and Bankruptcy Code (IBC) of 2016 is 324 days; it is much better compared with 4.3 years earlier. In FY19, of the 1,143 cases under the IBC, resolution was hammered out in 32 per cent of them, but it took more than 270 days under the Code. In a few big-ticket cases, nothing but files moved for well over 400 days. It’s a big drag on banks, and its knock down effects include the inability on the part of banks to pass on policy rate cuts by Mint Road to borrowers.

Says AK Pradhan, managing director and chief executive officer (MD & CEO) of United Bank of India: “The judiciary should respond in a time-bound manner under the IBC. In some cases, the resolution process has exceeded 600 days. In the case of debt recovery tribunals, huge amounts of public monies are stuck. As for the Sarfaesi Act (Securitisation and Reconstruction of Financial Assets and Enforcement of Securities Interest Act), government officials, unfortunately, do not provide the kind of support needed.”

Recovery through the IBC was Rs 70,000 crore in FY19, twice the Rs 35,500 crore recovered through other resolution mechanisms such as the debt recovery tribunal, Sarfaesi Act and Lok Adalat in FY18. Notes Gurpreet Chhatwal, president-CRISIL Ratings: “The recovery rate for the 94 cases resolved through the IBC by fiscal 2019 is 43 per cent compared with 26.5 per cent through earlier mechanisms. What’s more, the recovery rate is also twice the liquidation value for these 94 cases, which underscores that value maximisation is possible through the IBC process.” 

That said, is more bad news in store down the line? Especially, from the micro, small and medium enterprises (MSMEs)?

From January this year, dues payable to banks by both GST-registered and non-registered MSMEs are to be aligned to the extant 90-day past due dud-loan norm from the 180-day grace given in June 2018. Just how this shows up as non-performing assets (NPA) in a bank’s books will be fully visible in the second quarter of this calendar year — when two consecutive 90-day slots would have run through.

North Block’s infusion of an additional Rs 48,239 crore in state-run banks earlier this year brought the curtains down on a two-year recapitalisation plan set in motion in October 2017; it adds up to a tidy Rs 1.96 trillion. Five banks — Allahabad Bank, Corporation Bank, Bank of India, Oriental Bank of Commerce, and the Bank of Maharashtra — which were under the central bank’s Prompt Correction Action framework now breathe free, but the correct picture on their health will be known only after their annual inspection reports for FY19 are placed before the central bank’s Board for Supervision. It’s the reason perhaps for the indefinite postponement of the Indian Accounting Standards, which would have called for provisions on expected credit loss from the time a loan originates rather than waiting for trigger events.

Says Rajnish Kumar, chairman of the State Bank of India: “A lot of work has happened in the case of banks, especially state-run banks. There has been substantial recapitalisation and many of them have begun to report profits. May be the new government will take a call on further consolidation and merger among them.” What’s unsaid is that a shotgun merger between weak and strong banks will not solve the issues on hand. A secondary fallout, according to Fitch Solutions, of the stress within the banking sector is the downside risks posed to the fiscal deficit. State-run banks are the largest buyers of government debt, implying that a slowdown in debt purchases could impact the government’s borrowing costs.

A house for NBFCs

NBFCs grew in spite of the adverse macro-financial environment with a consolidated balance sheet expansion of over 17 per cent in the first half of FY19 led by asset finance and investment companies. Despite the repeated infusion of liquidity by the Reserve Bank of India (RBI), only a few NBFCs have been welcome at the watering hole.

Says Ashish Gupta, analyst at Credit Suisse: “The domestic wholesale debt market appears to be differentiating among NBFCs. Only those perceived to be strong or backed by strong parents (Housing Development Finance Corporation, Life Insurance Corporation, Bajaj Finance, and Mahindra & Mahindra Financial Services) have been able to tap the bond markets, while issuances by the likes of Dewan, Indiabulls and Edelweiss have been minimal.”

Says Sunil Kanoria, vice-chairman of Srei Infrastructure Finance: “Measures to provide liquidity support are welcome, but more than that there is a need to provide regulatory support to help us cope with this transition. RBI and the new government would need to jointly address this”. He points to the fact that NBFCs, in order to turn around, need to sell off parts of their portfolio. “In this regard, the minimum holding period (MHP) of six months is a major impediment. The MHP also becomes a major roadblock for securitisation,” he feels.

The other demand by NBFCs is to allow systemically important players to mobilise public deposits, especially when the banking sector is not in a position to support them because of capital constraints. This will considerably bring down the cost of funds for NBFCs and also translate into reduced borrowing costs for their customers. Many like Kanoria are of the view that there is a strong case for merging banks with large NBFCs and more banking licences need to be issued so that the large NBFCs can convert themselves into banks now. It’s unlikely that these demands will be entertained by Mint Road in the immediate – deposit taking will bring to the fore the issue of cover for the Deposit Insurance and Credit Guarantee Corporation for NBFCs; as for conversion into banks, the record so far has been one of far too little licences.

The days ahead will also call for a very close working relationship between North Block and Mint Road. While RBI governor Shaktikanta Das has been seen as relatively patient with the financial sector, it could also be said that he did not want to push hard during the poll season. A closer reading of RBI’s Report on the Trend and Progress of Banking in India (2017-18) seems to show an urgency which Das has not so far publicly articulated. It notes  that in developed economies, supervisors’ efforts to discipline banks are complemented by market forces that anticipate banking stress and incorporate it in price discovery. 

In a developing economy like India, markets emit weak signals of imminent stress in banking. Consequently, policy interventions are warranted, and supervisors need to be proactive in dealing with stress right since inception. It’s evidenced in Mint Road’s appointment of R Gandhi, a former deputy governor to the board of YES Bank. If this is indeed the thinking within cadre-RBI, starting June, we will have a very busy finance minister.

Inputs by Anup Roy, Abhijit Lele, Namrata Acharya, Subrata Panda and Raghu Mohan