The RBI tightens up

The end of regulatory forbearance on CDRs

The Reserve Bank of India (RBI) apparently intends to combine the transition to a looser monetary regime with tighter prudential norms. On January 31, close on the heels of the rate cut, the central bank issued draft guidelines for higher provisioning of restructured loans and more stringent loan reclassification norms. Corporate debt restructuring (CDR) occurs when a distressed borrower formally negotiates a deal with easier repayment conditions. From April 1 onwards, fresh CDRs will be provisioned at five per cent. Provisioning will be increased in stages to five per cent on the existing stock of CDRs, which are currently provisioned at 2.75 per cent. Promoters must now commit to bring in the higher of two per cent of outstanding debt and 15 per cent of what the banks are foregoing. Further, lenders may only convert a maximum 10 per cent of debt into equity — a clause that would have blocked deals like Kingfisher Airlines, where lenders collectively converted over 20 per cent of debt into equity. The RBI has also plugged loopholes in the reclassification of CDRs to “standard”, or non-NPA, describing this as the “end of regulatory forbearance”. The existing guidelines allow a restructured NPA to be reclassified standard if the borrower pays some part of outstanding interest. Under the new guidelines, the entire restructured interest due will have to be paid for a year before reclassification. The tightened definition implies that a large percentage of restructured loans will remain NPAs, which are provisioned at 15 per cent.

By adopting these measures, the RBI is finally signalling a desire to clean up balance sheets. CDRs are at record levels and growing. In the short run, however, the worst-affected public sector banks (PSBs) will take a hit of between three and eight per cent of net profits, according to an estimate by Bank of America-Merrill Lynch. The total portfolio of CDR assets was above Rs 2.1 lakh crore by December 31, 2012 and Crisil expects it to cross Rs 3.2 lakh crore by March 31, 2013. Around 10 per cent of all PSB assets are in CDRs. Private sector banks are better off, with lower CDR exposure at 1.5 per cent of assets. The higher provisioning will probably be reflected in a 0.5 per cent cut in private bank profits. Even after the adoption of the new norms, the amount of sticky assets will still be underestimated, given exposures in sick state power utilities, which are benefiting from a bailout by the Centre in a scheme funded by PSBs. Bilateral restructuring, not involving a formal CDR request, is also excluded.

These are draft guidelines, which hopefully will be adopted without dilution. Deterioration in asset quality has been driven by an extended period of low growth and high interest rates. The market can discount risky assets, but only if those are properly reflected in balance sheets. In the short run, the end of regulatory forbearance may lead to an even larger gap between the valuations of private sector banks and those of PSBs. But it is the only road to a healthy recapitalisation of the banking sector.