Resolving stressed assets

The new package should not be used to kick the can down the road

The Reserve Bank of India (RBI) has accepted the recommendations of the expert committee constituted to suggest financial parameters for resolving bank loans affected by Covid-19. The committee, chaired by veteran banker K V Kamath, suggested a framework to deal with such loans in 26 sectors. This is an extraordinary situation in which the countrywide lockdown imposed by the government to contain the pandemic affected the revenues and the debt-servicing capability of a large number of firms in different sectors. Thus, it became important to support better-run firms and avoid unnecessary bankruptcies, which eventually would have affected the banking system. In the given context, the recommendations of the committee appear reasonable and have given broad operating guidelines to deal with the situation. The resolution will depend on financial parameters of firms such as the total outside liability to adjusted tangible net worth, the current ratio and the debt service coverage ratio.

The committee has recommended different thresholds for different sectors. Further, only those accounts that were classified as standard with arrears of up to 30 days as on March 1 will be eligible for relief and the resolution will need to be invoked before the end of the year. This is to ensure that relief is extended only to mitigate the impact of the pandemic. Additionally, according to the regulator, all the other norms under the prudential framework, such as the mandatory requirement of the inter-creditor agreement, will be applicable under this facility. Since banks would need to resolve stressed assets quickly, some of the requirements might delay the process. While the recommendations of the panel and the framework adopted by the regulator have safeguards, it will still be critical to ensure that this facility is not used by lenders to hide bad loans. The experience of regulatory forbearance has not been encouraging in India. Although such forbearance suits most stakeholders in the short run, it does not help solve the problem.

Besides, there are other related issues which need policy attention. For instance, the committee noted that about 72 per cent of banking sector debt that it analysed had been affected by the pandemic. It is important to recognise that both corporate and bank balance sheets were stressed even before the lockdown. The pandemic has clearly worsened the situation. Also, analysts suggest that a large number of firms would not be eligible for resolution under the new framework. It is not clear how banks will deal with such entities in the short run. Given the stress in the system, non-performing assets (NPAs) are bound to rise significantly.

Therefore, the RBI will need to ensure that NPAs are recognised in time and the banking system is adequately capitalised. Against the given backdrop, while private-sector lenders are building capital buffers, it is not clear how the government intends to recapitalise public-sector banks. A weak banking system will impede the flow of credit and adversely affect the pace of economic recovery. This being said, a durable recovery depends to a large extent on how quickly India is able to contain the pandemic. A continued surge in infection will delay the recovery and increase stress in the system. This would limit the efficacy of any resolution process and increase capital requirement in the banking system.