Bankers should be alive to the increase in risk

Some concerns have been expressed that the one-day default clause (in the new framework for resolution of stressed assets) is onerous. These concerns are not well founded. For cash credit account, the 30-day trigger has been retained. For term loans, where the repayment schedules are predetermined, borrowers need to and indeed have enough notice to arrange funds in time. It is a behaviour change in repayment of credit that has to come about. I must say here, on the basis of first few reports received from banks under the new reporting system, that non-payment on due date appears to be seen as par for the course by the banks and the borrowers. Data show that a large number of borrowers, even some highly rated ones, have failed on the 1-day default norm. This has got to change. If borrowers fail to pay on the due date because of a cash flow problem, banks should see that as an early warning indicator warranting immediate action. If borrowers, with ability to pay on the due date, delay it routinely or because they see other arbitrage options, that must change too. Bankers should warn their customers that 1-day default will lead to their being on watch for resolution.

This brings me to the next commentary on the revised framework. One of the general refrains is that there are delays in payment by buyers including, rather predominantly, government bodies and that it could lead to a significant increase in slippages. First, the repayment schedules of loans should take into account such idiosyncratic risks and accordingly be customised to suit the cash flow pattern of the borrowers. Second, there must be enough skin in the game from the borrower so that there are adequate buffers (debt service reserve accounts) to tide over temporary cash flow volatility. The present problem is that banks allow excessively high leverage thus leaving out any possibility that the borrower can be made to deal with emergencies. This has been possible in an environment in which both the lender and the borrower were not too keen to maintain the sanctity of the debt contract. Such poor credit culture must be incentivised to change and the revised framework is aimed to precisely achieve this objective. I want to mention here that for the small borrower who may not have the wherewithal to bring funds swiftly in the event of non-payment by clients, the framework makes an exception. The framework has been consciously made non-applicable to the micro, small and medium enterprises with borrowings of Rs 250 million and less.

One of the features noticed in the past was evergreening of loans to avoid the recognition of non-performance. At the same time, it is necessary to distinguish evergreening from grant of additional finance for meeting genuine business needs. The revised framework requires grant of additional credit facilities to a firm in financial difficulty to be treated as a case of restructuring and lists out the criteria for determining whether or not the borrower is in financial difficulty. Some have expressed the view that the criteria are too broad. The banks, through policies approved by their boards, should fix the parameters and ensure strict adherence thereto. We would expect boards to be reasonable in setting the parameters.

Some (have) questioned the timing of the February 12th circular. I would say certain changes are sooner brought in than later. The search for that perfect time for a long overdue reform can become a never-ending exercise. I would want to point out that the Sixth Bi-monthly Monetary Policy Statement, 2017-18, observed that there are early signs in the economy of a revival in investment activity as reflected in improving credit off take, large resource mobilisation from the primary capital market, and improving capital goods production and imports. Further, the process of recapitalisation of PSBs has got underway, which has enhanced their ability to provide for credit losses as well as, in case of better capitalised banks, to contribute to the credit growth. The RBI has directed banks to file insolvency applications against large distressed borrowers as mentioned earlier, and these accounts are getting resolved under the IBC. All these steps should improve credit flows further and create demand for fresh investment, which may further accelerate growth. The RBI believes that a focused framework for resolution of distressed borrowers which respects and enforces the sanctity of the debt contract is required to make sure that the excesses observed during the last credit cycle are not repeated and we don’t end up in a similar situation few years down the line.

You may be knowing that banks are required to keep provisions for loans on their books, to cover for future expected losses. This means that as the likelihood of income or recovery from a loan decreases, the amount to be kept as provisions by the banks should increase. If the resulting drain on bank profits has to be contained, the action to address stressed assets should commence no sooner than the emergence of early signs of stress. Thus, bankers should be alive to the increase in risk as the probability of default increases and take adequate measures to contain the loss given default, such as through loan covenants, increased collateral, and/or higher risk premium, with promptitude. If such measures are not undertaken in time, it becomes too late to do anything outside of bankruptcy proceedings.

In fact, such timely intervention should be second nature to a bank. Similarly, paying dues on time should be the natural behaviour expected from a borrower.

The revised framework seeks to inculcate such a behaviour in both lenders and borrowers so as to create a credit culture that is conducive to a safe and sound banking system and a vibrant business environment.

Reserve Bank of India Deputy Governor N S Vishwanathan’s speech at the 14th Convocation of the National Institute of Bank Management, Pune, April 18, 2018