Unless banks lend, how will they come out of PCA?: Financial Services Secy

The NPAs peaked at 11.6%(by the end of March 2018) and have reduced by Rs 360 bn in the first two quarters of this financial year

The government and the Reserve Bank of India (RBI) have agreed to sort out their differences on some key issues affecting the economy.  Ahead of the RBI’s next board meeting on December 14, Financial Services Secretary Rajiv Kumar talks to Somesh Jha about the government’s views on some of the points of friction and the series of reforms the government has taken to strengthen public sector banks (PSBs). Edited excerpts:

Liquidity as a huge concern seems to be over for non-banking financial companies (NBFCs). What steps are you looking at to boost liquidity further? 
 

After banks slowed down lending after a period of aggressive growth, NBFCs took over. But the question is not at what rate you grow, it is also about asset quality. While liquidity is not an immediate issue now as most of the borrowings have been rolled over, the need is to have a robust system in place. It’s high time one looks at the rating agencies as well. There cannot be a situation where an ‘AA+’ rated company gets down to junk status in just one day. The market regulator should look at bringing in transparency and accountability. The entire ecosystem in the financial landscape – shell companies, black money, cleaning of banking, NBFCs, and ratings – is being simultaneously looked at and cleaned up.

What cushioning do we require for NBFCs?
 

Growth should continue because they have served retail, housing, and rural areas well. We have to ensure liquidity, good asset quality, and the interest rate regime is not unreasonable.

Some banks under prompt corrective action (PCA) have improved lending and their overall performance. Why does the government want PCA norms to be tweaked at this point?
 

The government is not asking for any relaxation. We are saying align it (the RBI regulations) to the best of the best in the world, but don’t keep the parameters higher. PCA norms, which are used as early warning tools by regulators abroad as well, is essentially about capital. (But) we are keeping asset quality and return on assets (ROA) as an extra parameter. Align it to the best, otherwise the income will not come. If that doesn’t happen, banks will not come out of PCA.

Give me any model by which without lending, you can come out of PCA. If you are not allowed to lend and continue those higher things, how will that happen? I agree not every bank has improved, but they are trying their best. Their net non-performing assets (NPA) and provision coverage ratio have improved. Some of them have improved more than the others. You need to pat the good child who is performing better and align it with the best international practices. An early intervention regime requires only capital as a base which, in our case, is 1 per cent higher in any case. Instead of 8 per cent capital to risk weight asset ratio, we have 9 per cent. So that cushion is already available.

Do you feel a regulatory overreach has delayed the recovery of banks’ health as NPAs are still high and banks continue to register losses?
 

The NPAs have peaked already. In the last two quarters, they have started coming down. The NPAs peaked at 11.6 per cent (by the end of March 2018) and have reduced by Rs360 billion in the first two quarters (of this financial year). Four Rs are on simultaneously – recognition: provisioning coverage ratio is increasing; recapitalisation has taken place; recovery is at its peak; reforms are under way. The entire system is on a reboot and I see a bright future for banking. 

For a country like ours, you require strong banks for scale and synergy and that is the reason why amalgamation took place. You need technology to take it forward because of which financial technology came into the picture to link all the data points. You require strong human resource (HR) reforms and most importantly, borrowers need to understand that both borrowers and banks have to be responsible and you can’t run away with public money.

When can banks be expected to be pulled out of PCA?
 

Under the present regime, they will take time. And if the ROA for two years is kept, it will become even more difficult. It has to be pragmatic and rational without compromising on what Basel says and what is the best that needs to be prescribed. It should be based on improvement. One should not argue that everybody should be just taken out with one brush and thereby lose the purpose of this exercise.

Why is the government seeking governance reform in the RBI in the next board meeting?
 

No dilution is being sought or should be asked for. The integrity and respect for the institution should always be preserved. It’s only within the mandate of the Act (that we are seeking some changes). And we will ask for what the Act suggests, nothing more. There should not be any dilution of the institution or the Act whatsoever.

Will you push for government nominees to be a part of the board for financial supervision (BFS) of the RBI?
 

We have never asked for government representation on the BFS. It should be in a way that it is not a closed-door discussion.

Invoking of Section 7 of the RBI Act is surely an attack on the independence of the regulator. Why did the situation arise?
 

We never invoked it. The RBI Act very clearly defines the law of the land. Consultation was ordered by the Allahabad High Court. The court mandated that you initiate the consultation process. In that reference, the consultation began but was never exercised. Now, the Supreme Court is hearing the case. If the court gives you a direction, there is no option but to follow it. But still there was no direction given. There are ways of resolving the issues. We have not sought relaxation and forbearance; it’s only an alignment (of RBI norms) with Basel – the best in the world, without compromising on any of the cleaning-up agenda as the ultimate objective.

What is the broad message from the last RBI board meeting?
 

It was a very cordial meeting. It was intellectually very stimulating because the expertise in the RBI is tremendous. They look at it from a long-term way, which is robust. The alignment was discussed at length and it’s a healthy sign to have a dialogue, following which a decision was taken and was announced in the form of a statement from the RBI. It was a robust way of dealing with things, I suppose.

RBI Deputy Governor Viral Acharya said in a public speech last month that the government plays T20 and the central bank plays Test cricket. Your view.
 

I won’t react to this. These are individual things.

Is there a reassessment of capital needs for PSBs. A recent report pegged the recapitalisation requirement for this fiscal year at over Rs1 trillion – almost double the government’s plan for fund infusion?
 

We have budgeted to put in Rs 650 billion in PSBs this year. It’s an evolving situation always, but should be alright.

How much will the RBI board’s move to defer maintaining capital conservation buffer (CCB) to next year help?
 

Firstly, the CCB is built during good times and never during a period of stress. In our case, it was built in the period of stress. Strictly, in that sense, it’s not deferment, but an alignment to Basel norms. As I have said, one is not looking for any relaxations since banks should stand on their own feet. Otherwise we will lose the entire story of making them responsible. It should free up Rs 360-370 billion, but they have to build it up again next year.

The RBI has often argued that recapitalisation should accompany HR reforms in banks. What HR reforms is the government planning?
 

There are three-four major decisions we have taken on the HR side. As a first step, we decided that the appointments at senior-level position in PSBs should be at arm’s length to the government’s, along with being transparent. The Banks Board Bureau (BBB) was appointed, which is represented by the deputy governor of the RBI and other expert members, which takes the decision. There also, six members are divided into three sub-committees and they take separate interviews without telling each other how much marks they have given. Then average and mean is taken, so that the best is selected.

We have started announcing the results the same day, so that any lobbying or influence is ruled out. Allocation in bank is on the basis of merit-cum-preference. If you are No. 1 on the merit list, you can choose to go wherever you want. The government has no choice at all in assigning someone a particular bank. 

The second problem is at the middle level, where the pipeline is weak. We have appointed an HR agency through the BBB to look at the entire landscape of middle management, put them through a tremendous test, and find out who has the potential to grow, so that we can train them for six months. The system will throw up the best 75 who can aspire to grow higher. It also gives a message to others that you have to either come to this level and there is a clear signal that merit will be recognised. There is no lobbyist for appointment these days and this is one of the most significant HR reforms we have undertaken.

Why are you insisting on RBI nominees in PSB boards despite the regulator’s reluctance?
 

If I put government nominees, you would say that I am interfering in credit decisions. We want to be absolutely out of any credit decision that banks take. The RBI nominees have been there for a long time. It gives us comfort and it doesn’t interfere in regulation or supervision as such. Government has considered it and has decided to continue with the practice, especially till conditions improve and banks are fully cleaned up. Nobody can doubt the professionalism of RBI officials. 

But RBI Governor Urjit Patel has been vocal about it.
 

Yes. He has written to us and this has been our reply to him. He has a point that why RBI should be there. But it is a question of timing. When you are cleaning up, you need the strength and support of the RBI.

Despite the RBI’s presence on PSB boards, there have been instances of fraud. Who do you blame?

There is no blame game here. Everybody has to take the blame. It was the entire ecosystem which was working. But it has tightened now. 

What about professionalising the PSB boards?

Three things happened there. Firstly, five big banks have been opened for entry from the private sector banks, including IDBI Bank, Canara Bank and Bank of Baroda. Secondly, the position of MD and the Chairman were segregated. For the chairman's post, private sector players were roped-in so that the role-definition took place. Further to ensure that the MD doesn’t influence the board. 

The third important thing is that on the board, under the EASE reforms agenda, you have empowered the board and reviewed the functioning of the executive directors which were unavailable earlier. Thus enabling the EDs to be accountable to the board.
 

These are few steps undertaken to professionalise the boards.

But the response from the private sector professionals has been weak. The private sector players feel they have no powers being on board of PSBs. How do you respond to that?

You are basically talking about the non-executive chairmen. MDs have as much power as any other MD. The balance between the Non-executive chairman and MD is equal. The administration and execution, which is a day-to-day task, has to be left to the MD. So it’s only the control in the board through the executive chairman. We consulted and called all non-executive chairmen, then we decided that the appraisal of the EDs is one power given to the board and non-executive chairmen can, while chairing the board, lay any policy.

But yes, I agree that they feel far more involved in the policy-making. They want liberty in two-three fields, (but) let me be very upfront: they can’t hire as much as they want. So, being a public sector bank you don’t have the same liberty as you have in the private sector. Hiring anybody, at whatsoever cost, is not possible since you are bound by certain rules and regulations. You can’t hire laterally as it disturbs the entire hierarchy. But still, the boards are empowered to look at some areas where they can hire experts: Technology, risks and treasury.

Why do we require restructuring of MSME loans despite having govt's special focus on this sector through schemes such as Mudra?

We need to look at it this way – when the corporates come in trouble, it has a trickle-down effect on MSMEs. In many cases, MSMEs actually cross-subsidise the big corporates. Whenever a technology upgradation is required, it is being done by ancillary at its own cost, and when inventory is being maintained, it is being maintained by MSMEs at its own cost. When a material is supplied, it takes time in getting accepted. Following which, it takes time in credit system. So, the entire cash cycle of MSME gets disturbed. When the health of the mother, which is a big corporate, is in a bad shape it has more impact on MSMEs. The cash cycle then becomes a problem in this case. 

If MSMEs are closed for one year, then the entire process becomes difficult to revive. Though the bigger ones can be revived, smaller firms, if not helped, can go haywire.

A window is available in the RBI’s February 12 circular (norms dealing with stressed assets) itself which says that loans below Rs 250 million can be given some relief. Now, no bank can actually lend to them if you have asset reclassification. So what was decided in the RBI's board meeting was to give them a window like the saying that says: Don’t marathon today. We, therefore, give you six months time, that's when you prepare yourself and then run a marathon. That’s what it is.

Do you see the risk factor attached to it, in the form of NPAs?

The SMAs (Special Mention Accounts) have come down very drastically. It’s not only the NPAs that are getting recognised but SMAs are also coming down since the stock has been tackled – therefore it becomes into a stock problem. Now, whosoever has survived is of better quality otherwise it has already slipped into SMA or NPA. So this window allows those who are probably the sounder one that would survive. Else, if it has already been converted into NPA, then it becomes unavailable. This window is available when they undergo the process of GST, formalisation and therefore a bit of handholding – as I mentioned. The balance sheet size is shrunk – through a little bit of cash flow-based lending and should not be looked at as a dole. We are doing handholding for a year to sound GST-registered, formalised, standard accounts. Instead of two quarters, we are saying five quarters and nothing else. 

What is the government’s step to ensure such bank loan defaulters do not run away from the country since we have witnessed a slew of cases in the recent past?

There are three steps to this. The creditor-debtor relationship is going through a sea change in the country. People have realised that if you have taken loans, you have to give it back so it’s payback time. The first thing we have done is to ensure that the banks take passport details for all loans above Rs 500 million. Then on, the Fugitive Economic Offenders Act will help us take action in case somebody has fled the country. Lastly, something which was done a few days back was that the chief executives of public sector banks (PSBs) were never authorised to request for Look Out Circulars. Earlier, economic interest was not the reason for issuing an LoC and it was only possible after filing a criminal case. Now, PSB chief executives have been enabled to do so in cases where economic interest is involved. This puts responsibility on the bankers to be more vigil, also empowering them. Similarly, people were also taking advantage of that situation. We will not allow anybody to take advantage of the loopholes.

How productive will it be for the economy to move from corporate loans to retail loans as envisaged in the government’s EASE agenda for PSBs?

There are four segments to the lending space – infrastructure, big corporates, MSMEs, retail and the unfunded that has nothing. Banks are targeting all of them. While the big ones are going through some cleaning, infrastructure is to be done by a specialised agency. Therefore in the EASE agenda, we said it’s a differentiated banking strategy and everybody will not do everything. If you are specialised in MSME--go for it. 

Now the third space is the MSME which requires a whole lot of support, including the 12-point reforms announced by Prime Minister Modi that are underway. Retail loan is for the middle and lower-middle class segment for housing and consumption purposes. This area was occupied by private banks working in the urban area. This is a good portfolio and we also suggest that all this should be available from the comfort of one's home. People should not be forced to visit the branch. It should be as seamless as buying a railway ticket or applying for a passport online as it reduces the risk of fraud and gives you a whole level of comfort.