RBI cracks the whip: New NPA rules may mean short-term pain for banks

The Reserve Bank of India (RBI) has turned up the heat on banks and companies defaulting on loans by coming out with a leaner framework for the resolution of non-performing assets (NPA). The new framework, which subsumes most existing stressed asset schemes such as the Strategic Debt Restructuring Scheme (SDR) and the Scheme for Sustainable Structuring of Stressed Assets (S4A), gives primacy to the Insolvency and Bankruptcy Code (IBC) of 2016, and has disbanded the concept of a Joint Lenders’ Forum. The new framework for resolution of stressed assets was anyway inevitable since India now has a bankruptcy law and the experience with previous stressed asset schemes has not been encouraging. It is an open secret that these were used by many banks as well as their corporate borrowers to resort to evergreening of loans.

 
The other big change is the focus on timely identification of bad loans and the speedy resolution of such assets. With the JLF out of the way, the new RBI guidelines demand that banks identify stressed accounts as soon as they go into default. Banks are supposed to categorise them as special mention accounts, report to the RBI and start the resolution process straight away. The central bank has also toughened the reporting of default to the central repository by making it a monthly, instead of a quarterly, requirement. All borrower entities in default with an exposure of more than Rs 50 million have to be reported on a weekly basis. The point is not just to report sooner but also to act fast as well. As such, the RBI has also clarified that as soon as there is a default in the borrower entity’s account with any lender, all banks, singly or jointly, shall initiate steps to address it. In other words, banks will be obligated to start the resolution process. The RBI has laid clear timelines, not exceeding 180 days from March 1, for the resolution process to yield results, failing which insolvency proceeding will have to commence within 15 days. At the last count, that is, as of September 2017, NPAs with listed Indian banks had grown to over Rs 8.4 trillion. Such high levels of NPAs have progressively crimped the ability of the banking system to extend fresh loans to businesses that could provide a fillip to the economy.

 
The new framework will obviously lead to short-term pain for many banks and may throw up challenges for borrowers. For example, the strict timelines to come up with a resolution plan could mean that a larger number of accounts will go into insolvency. The haircuts that banks may need to take and the probability of liquidation in some accounts will also rise. Besides, the condition that a restructuring plan must be agreed upon by all banks involved in large accounts may be difficult to implement as experience shows such a thing rarely happens. The RBI may have to take a fresh look at this aspect. Over the long term, however, the revised framework should work well as the process still provides over one year to resolve a stressed assets problem -- initial 180 days to implement the resolution plan and then another 270 days under the IBC.  Against the background of the earlier resolution process not meeting expectations, the RBI should be complimented for initiating this much-needed reform.