Rally in PSB stocks looks justified

Banks hope new rules will resolve bad loans faster

On a day when most indices were in the red, the Nifty public sector bank (PSB) index rose 1.3 per cent on Monday. The reason for the optimism on PSB stocks is that the new resolution mechanism, likely to be announced in the next few weeks, is expected to give PSBs leeway to recover bad loans and improve pace of bad-loan resolution. Well, this isn't the first time that PSB stocks are getting jubilant about such likely initiatives, and the past two years have seen bankers work particularly hard to resolve bad loans.

First in June 2015, the provisions for corporate debt restructuring (CDR) came to an end, giving way to strategic debt restructuring or SDR. In less than a year, SDR was reoriented as scheme for sustainable structuring of stressed assets or S4A, which improved the implementation of the norms while vesting banks with more powers. Yet, bankers have made very little headway in resolving bad loans. With banks unwilling to decide on the amount of haircut (percentage by which a loan's market value is reduced) to undertake, resolution mechanisms such as S4A have not found much acceptance. 

"Assuming that a problematic loan account was doing well in terms of business sustainability and was only facing operational challenges, the average haircut banks must have undertaken was 25 per cent. In sectors like iron and steel, the best-case scenario was even 40 per cent. In the worst case, it was as high as 70 per cent," says Abhishek Bhattacharya, director, India Ratings and Research.

But this could change with the introduction of new norms for resolution and restructuring of bad loans, which experts believe may be introduced in a few weeks.  Bhattacharya, based on his interaction with bankers, says lenders are now quite upbeat on the idea of new resolution and restructuring norms. "For long, they have wanted to formalise a few scenarios and bring in an external agency to assess the situation," says Bhattacharya. Experts believe that the new mechanism, which may be more flexible in restructuring of loans, could bring an external party like a rating agency to decide amount of haircut. This could bring much-needed relief to banks, especially for PSBs, where government scrutiny tends to be high with respect to haircut on bad loans.

Seen from this angle Ambreesh Baliga, expert, feels the rally in PSB stocks is justified. "For rally to be justified, investors will have to watch out loan growth," he says.