MACROSCAN. Saving India’s public sector banks

Banks in India, especially those in the public sector, are stressed, argues the Reserve Bank of India in its recently released Financial Stability Report.

That refrain is familiar. For some time now, it has been clear that stressed assets (the combination of non-performing and restructured assets) in the banking system, particularly in public sector banks (PSBs), has been rising rapidly.

The ratio of stressed assets to gross advances has risen from around 6 per cent at the end of March 2011 to 11.1 per cent by March 2015 (Chart 1).

This problem is unevenly distributed. PSBs recorded the highest level of stressed assets at 13.5 per cent of total advances as of March 2015, compared to 4.6 per cent in the case of private sector banks (PVBs).

The share of restructured assets in total stressed assets is high, and explains a larger proportion of the rise in the total.

An asset is restructured when lenders suspect that a large borrower is likely to default on payments to an extent where the loan has to be declared a non-performing asset warranting provisioning.

Restructuring a loan involves measures such as extending the maturity of the loan, reducing the interest rate charged, converting a part of the loan into equity, providing additional financing, or some combination of these.

In the case of the corporate sector, such restructuring is facilitated by the corporate debt restructuring (CDR) mechanism initiated by the Reserve Bank of India in 2001.

Under the CDR mechanism, once the debt of a borrower is restructured, the lender need not classify it as a non-performing asset (so longer as no further default occurs), and, therefore, can put aside much less than otherwise required to provide for any likely loss, with much less damage of profitability.

There was a reason why the government as part of financial liberalisation chose to adopt a corporate debt restructuring scheme, besides encouraging and incentivising mechanisms such as “take-out financing”.

Take-out financing applied to long-term projects allows one set of institutions to provide loans for the initial phase of a long-life project (say five years), with the promise or commitment that the loans would be taken over by another set of institutions.

Schemes such as these help banks with deposits that are relatively short-term and liquid to invest in capital intensive projects with assets that are illiquid and require long- term financing.

With the aid of devices such as these, banks — especially those in the public sector — that had for long avoided exposure to such projects involving maturity and liquidity mismatches, were persuaded to enter these areas.

Lending to projects such as power, iron and steel, telecommunications and infrastructure such as roads and ports rose sharply in the years starting in the early 2000s, increasing significantly the share of such advances in the total.

Encouraged by the availability of advances of that kind, private investors flocked to these areas either on their own or through public-private partnerships.

The result was a spike in private investment in these sectors. However, expectations that these investments would prove lucrative were often belied, making it difficult for these borrowers to meet their debt services commitments.

By December 2014, the industrial sector as a whole was recording the highest stressed assets to advances ratio of 17.9 per cent, followed by services at 7.5 per cent.

As Chart 2 indicates, the share of mining, iron and steel, infrastructure and aviation in total advances of the scheduled commercial banks (SCBs) stood at 21.4 per cent in December 2014.

On the other hand, their share in the stressed assets held by the SCBs was a huge 53.8 per cent. The figures for PSBs in particular were 25.1 and 43.6 respectively.

The possibility of default this implied pushed banks to exploiting the corporate restructuring mechanism to save themselves from the hit on balance sheets that declaration of an asset as non-performing would involve.

The number of CDR cases approved per year rose from 8 in 2009-10 to 84 in 2012-13, and then came down to 67 in 2013-14. The exposure that was restructured rose from ₹10,758 crore in 2009-10 to ₹99,476 crore in 2012-13 (Chart 3).

However, when defaults on restructured loans also began, it became clear that the CDR mechanism was only being used to conceal bad assets by postponing the day of reckoning.

Hence the government and the RBI decided that as of April 1, 2015, banks would have to treat restructured loans as non-performing and set aside 15 per cent of their value against provisioning, as against the 5 per cent required till then.

The RBI governor Raghuram Rajan reportedly said, “It's important we clean up bank balance sheets and show what they actually contain. That will enhance confidence in bank balance sheets and enable banks to raise the much needed fresh capital. In order to build confidence in bank balance sheets, we have to come to an end of forbearance.”

Since this decision was announced early, the expectation was that banks would use the opportunity to restructure all their doubtful loans before the deadline (April 1, 2015) and get the benefit of deeming the assets to be restructured to be “standard” assets.

Surprisingly, however, the number of cases for restructuring approved by the CDR cell fell to 30 in 2014-15, as compared with 67 a year earlier, and the exposure restructured was only ₹39,230 crore as compared with ₹99,476 crore in the previous year.

The explanation for this disinterest is to be partly found in the decision of the RBI to go back on its push for transparency. This it did by offering banks a way to ‘exit’ from non-performing assets through a refinancing scheme. In what came to be known as the 5/25 scheme, in July 2014, banks were allowed to extend long-term loans of 20-25 years, supposedly to match the cash flow of projects, with the option of refinancing them every five or seven years. Refinancing would allow the banks to reset the terms of the loan, in a manner similar to what happens under restructuring.

The 20-25 year maturity period gave firms the opportunity to amortise debt in much smaller doses, even if it implied a higher interest rate.

When first announced, the 5/25 scheme was available only to new projects. But in December 2014, the RBI extended this flexible refinancing and repayment option for long-term infrastructure projects to existing ones, where the total exposure of lenders was more than ₹500 crore.

What is more, while the CDR scheme required the promoter to bring in more equity when the restructuring was being negotiated, this was not required when the refinancing option was relied on.

It did not take long for banks to recognise this as another opportunity to avoid declaring loans as non-performing and therefore carry the burden of provisioning.

While aggregate data on the use of the scheme is difficult to come by, there have been reports of large players exploiting the option.

Adani Power through two subsidiaries — Adani Power Maharashtra (APML) and Adani Power Rajasthan (APRL) — reportedly struck a ₹15,000-crore term-loan refinance deal. Others such as Jaypee Infratech and GMR Infrastructure are also reported to have opted for this scheme.

This popularity of the new scheme suggests that the availability of this opportunity does explain the fact that the hit from the end of the benefit of treating restructured assets as standard has not been as large as expected.

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