India's Framework to Resolve Distressed Assets Is Credit Positive for Banks

Srikanth Vadlamani, Vice President - Senior Analyst, Moody's Investors Service

Last Thursday, the Reserve Bank of India (RBI), the country's central bank, published new rules to improve and accelerate the identification and resolution of banks' distressed assets, effective April. The framework is credit positive for Indian banks, particularly public-sector banks that have higher levels of impaired loans, because it requires early recognition of stressed assets and incentivizes banks to cooperate with one another to resolve those assets. The framework also provides for penalties for so-called willful defaulters and non-cooperative borrowers, and encourages the development of an active market for distressed assets. If implemented as designed, these measures will improve banks' ability to resolve distressed assets.

The framework will require banks to segment special-mention loans into three sub-categories: loans overdue for less than 30 days but showing signs of incipient stress, loans overdue 31-60 days and loans overdue 61-90 days. If a loan becomes overdue for 61-90 days, and the aggregate exposure of banks to the borrower exceeds INR1 billion, the RBI will require the affected banks to form a joint lenders forum and put together a joint corrective action plan to resolve the borrower's distressed assets. The joint lenders forum must decide on terms of the resolution package to the borrower, and convey these terms to the borrower within 15-90 days, depending on the size of the loan and the resolution plan.

The RBI will establish a centralized database to collect, store and disseminate data on large borrowers to all lenders in the banking system, which will lead to a more transparent recognition of the extent of distressed assets. Currently, it is possible for a borrower to be overdue on its obligations with one bank, but still be treated as a standard account at a different bank. The new mechanism will ensure that such assets are recognized as distressed assets across the system. This new transparency may increase the level of reported nonperforming assets in the system.

The framework also has incentives for lenders and borrowers to adhere to these guidelines, and penalizes those that do not. Any asset that has been restructured as part of a corrective asset plan will retain its existing asset qualification after the restructuring. However, if any of the lenders that have agreed to the restructuring later back out of the plan, the lender will be subject to accelerated provisioning requirements.

Also subject to the accelerated provisioning requirements are lenders that fail to convene a joint lenders forum or fail to agree to a plan within the stipulated timeframe and loans to companies whose directors' names appear on the willful defaulters list more than once. Any new loans to borrowers indentified as non-cooperative, or new loans to companies that have non-cooperative borrowers as directors, will also be subject to the accelerated provisioning requirements. The RBI said the measures against non-cooperative borrowers seek to remove bottlenecks to banks' bona fide resolution efforts.

The RBI's framework also seeks to encourage the growth of an asset-reconstruction industry in India. It incentivizes banks to sell their bad loans by allowing them to recognize any gains on such sales upfront, to recognize losses over two years, and to use floating provisions as specific provisions for those assets that are being sold off. The RBI proposes to ease regulations on bilateral sales of nonperforming assets. To encourage demand for such assets, the RBI will consider allowing asset-reconstruction companies to raise debt funds, and allow banks to extend financing to specialized entities established for the acquisition of distressed assets. The RBI also proposes to encourage participation of select private-equity and non-banking finance companies in the asset-reconstruction industry.

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