Bad debt and NPA: making sense of banking mess

FM asked banks to go after loan-defaulting promoters. But the public fund siphoning will continue unless deeper, systemic solutions are put in place


Alam Srinivas | September 7, 2013

Finance minister P Chidambaram
Finance minister P Chidambaram

In 2008, Indian policy makers boasted that the global financial crisis would not affect the future growth in this country. In November the same year, the then finance minister P Chidambaram told an international business audience that “we will be back to a high growth rate (of nine percent)” by the end of 2009. He, along with a few economists, insisted that the country’s financial system, especially the banking one, was fairly insulated from the global catastrophe.

Almost 52 months later, the FM sang a different tune. In March 2013, he told parliament that “it is not a correct assessment that we were not affected by the 2008 banking crisis.” He added that the crisis “did not end in 2009. It deepened in 2011-12”. This was the reason that Chidambaram publicly asked the banks to go after ‘willful defaulters’, or those (corporate) borrowers who have made a habit of not repaying their loans and allowing their companies to go bankrupt.
The ugly fact is that the Indian banks are in shambles. In the past year or so, their levels of bad loans, or those that may never be repaid, have shot up alarmingly. Total NPAs (non-performing assets or bad debt) of 40 listed Indian banks have zoomed by over 40% -- from Rs 1.25 trillion in December 2011 to Rs 1.79 trillion in the same month in 2012. In a few cases, like Punjab National Bank and Indian Bank, the overall NPAs have doubled; in the case of Central Bank of India, they were up over 50%.

More importantly, experts question the ability of the banks, the regulator (RBI) and the finance ministry to recover this debt. The reason: apart from the large borrowers, like powerful business persons, the fault for this financial mess also lies with the policy makers and RBI. All three are equally responsible. However, in a bid to distance from the problem, each section blames the other. Thus, Chidambaram’s diktat on ‘willful defaulters’ may be an exercise to divert attention from his blunders.

Banks: From NPAs to CDRs

For several years, the banks found an easy way to hide their bad loans. They neither wrote off the loans, nor admitted they would not be repaid, nor did they force business persons to pay up. Instead, they opted for what is termed corporate debt restructuring (CDR). In such cases, the loans were merely restructured – the promoters were given a moratorium and asked to repay after a couple of years, interest rates were reduced, and part of the loans were converted into equity. This ensured that the loans did not become part of the banks’ NPAs.

According to government officials, Rs 3 trillion worth of debt in only the infrastructure sector has been restructured in the past few years. Bankers complain that the number of proposals they received for CDR packages has risen in the past few months. In a recent interview, the CMD of Allahabad Bank, Shubhalakshmi Panse, claimed that the number of CDR packages would increase over the next 6-9 months, and many promoters have asked for a second round of debt restructuring.
In retrospect, CDRs delayed the inevitable in most cases. Several companies that got two rounds of CDRs – loans have to be classified as NPAs after the second round of CDR – ended up being sick or had to be sold to a new owner. The classic case is that of Ispat Industries, which was owned by the Mittals and, in end-2010, sold to Jindal Steel. Its debt history in the past 10 years proves the complicity of the lenders to bail out the promoters. Instead of trying to get back their money lent to Ispat, the banks helped the promoters to continue with their unviable ways.

The first CDR of Ispat Industries was finalised in 2003 and, six years later, as the company continued to be in trouble, the debt restructuring package was reworked to give the company more time. Nothing worked. The company remained in the red and asked for the third CDR in 2010. That’s when the banks said enough was enough, and forced the Mittals to sell out to Jindal Steel. Shockingly, now the Jindals may get a new CDR package, expected to be finalised within a few months.

However, the Mittals took the banks for a long ride. Both in 2003 and 2009, they promised the lenders that they will mend their ways. They claimed that they would achieve quick financial closure for their several stuck projects such as the captive power plant, one million ton capacity coke oven, and the 2 million ton pellet plant. The Mittals said that they would sell the flats at their Pedder Road (Mumbai) property to infuse cash into the company. They reneged on most of these promises.

It was not only the fault of the banks, which refused to force the promoters to implement these decisions, and the Mittals, who found excuses. The company was not in a position to do well because it had inherent problems. Even if the Mittals had delivered on their commitments, the adverse scenario in the steel sector would have pulled down Ispat Industries. Therefore, it was incredible that once Jindal Steel purchased it, the banks were willing to give it another chance.

Today, the Jindals have decided to refinance the Rs 75 billion debt through another set of banks. So, new lenders will pay off the older ones, and restructure future payments along with a moratorium. It is shameful that a company, which has underperformed, gets three CDRs in a decade. This reflects poorly on the Indian banks. “Maybe the banks’ representatives on boards of several companies should be pro-active to prevent defaults or bad loans,” feels economist Bibek Debroy.

RBI: Policy sops to defaulters

Obviously, the regulator should have stopped the banks’ practices. Instead, it encouraged it; in fact, the RBI gave more freedom and flexibility to the banks to offer CDRs to corporate entities. First, it set no limits on the number of debt-restructuring packages given to a single company. Second, there were no restrictions on a single promoter, who got several CDRs for different firms in his/her group. There was, thus, no concept of a group approach in debt recast, although a formula is in place for loans. For example, a bank’s loan exposure to a sector or a group is defined.

Thirdly, as per its May 2005 guidelines, the RBI washed its hands off CDRs. The regulator stated that its role in debt restructuring would be “confined to providing broad guidelines” and its officials would not participate in the actual discussions and negotiations between the banks and promoters. The entrepreneurs were thus free to politically and otherwise influence the banks’ CMDs through their connections and get reprieves on repayments of their loans.

Fourthly, the May 2003 guidelines extended CDRs to even the ‘willful defaulters’, the same ones that the FM now wants the banks to take action against. The CDR Core Group, which was carved out of the CDR Standing Forum, which had representatives of the banks, could approve such debt recast to deliberate defaulters if the former felt that the latter would rectify their mistakes. Clearly, this left a huge window of opportunity for the promoters to get their way.

More importantly, in many cases the RBI has encouraged CDRs in a specific sector. For instance, in mid-2010, the central bank approved a package for the aviation sector since it believed that most airlines were, or on their way, in financial trouble. Since then, only one carrier, Kingfisher Airlines, has taken advantage of the RBI decision. In October 2010, Kingfisher’s debt was restructured with a moratorium, lower interest and part conversion of loans into equity. Since then, the financial fortunes of the Vijay Mallya-owned airline have only become worse, and it has shut down its operations.

“As part of CDR committees, the banks have a conflict of interest. They are under pressure to show lower NPAs, and thus restructure the loans, and lend more each year. So, one can build a case for an independent authority, and not the RBI, to decide whether to sell the company’s assets, force a change in management, or push the existing owner to  initiate critical decisions,” says Debroy.

Policy makers: Crony banking

The central and state ministries contributed to the NPAs. Many projects, especially in infrastructure, get delayed or stuck due to lack of official clearances, like land acquisition and those related to environment and forests. This trend will get accentuated in the near future. Analysts says that several projects are due to hit project completion deadlines in 2013-14, when they have to technically begin to repay their loans. If these projects are delayed, their promoters may not be able to do so. One hopes that the new cabinet committee on investments (CCI) can deliver results.

In addition, Chidambaram has decided to take on debt defaulters for budgetary reasons. “His concerns for revenues and expenditure and, hence, fiscal deficit, have forced him to take this decision. But what we require is mindset and systemic changes,” explains Barun Mitra, founder, Liberty Institute. The FM realises that the government may have to extend huge sums to the banks – some contend the bailout amount to be $1.7 trillion – over the next few years in a worst-case NPA scenario.

Moreover, it is difficult to define ‘willful defaulters’. “In India, we consistently see that companies become sick, but not the promoters, whose personal wealth grows. This is unlike the US, where many entrepreneurs become bankrupt. Legally, it may be difficult to have a group concept for debt repayments. One should also not forget that many defaulters have political backing; the part of the reason is crony capitalism and the way it is practiced in India,” says Mitra.

Policy makers make it more difficult for the public sector banks because they have a huge say in the selection of their CMDs. Since these are political appointments, the CMDs operate with different mindsets. For example, towards the end of their tenure, they tend to lend more liberally or restructure debt more easily in a bid to show a better balance sheet. The new occupant does the opposite; he/she hopes to start with a clean slate. Normally, a change in chairperson leads to an increase in NPAs.

So, it is not just the chairperson of the bank who is responsible for NPAs; it is also the promoters with political connections, and the politicians, who have a huge say in the functioning of most banks, including the private ones. The RBI too with its hands-off approach, which cannot work without adequate regulation and monitoring, has to share the blame. Willful defaulters are a small part of the problem; lack of will and faulty regulations constitute the remaining portion.

This article first appeared on this website and in the magazine in April. Not much, of course, has changed sinced.




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