The ordinance on bad debt resolution is apparently intended to expedite the resolution — through restructuring or insolvency — of the large NPA accounts by providing an umbrella of the Reserve Bank of India’s diktat and protection for the process. One wonders whether the existing sweeping powers already available to the RBI under Section 35A, namely, to issue directions to bank/s were not sufficient, and that an ordinance was required?

The new Section 35AA provides for the Centre to authorise the RBI to issue directions to the banks to initiate the insolvency resolution process in respect of a default.

Does this imply that the RBI will be issuing directions to banks to put into the insolvency process, individual cases of large default that have not been resolved by any of the schemes already in place like the CDR, SDR, S4A? Is this not a decision that needs to be taken by banks and their boards rather than by the RBI issuing directions to them to initiate the insolvency resolution process?

A fear psychosis

The new Section 35AB(2) says that the RBI may specify one or more authorities or committees with such members as the Reserve Bank of India may appoint or approve for appointment to advise the banking companies on resolution of their assets.

The important word here is “advise”. In other words, the decision on resolution (unless taken under Section 35AA for insolvency!) will continue to be that of the bank management. Perhaps the hope is that if the decision has been taken on the basis of advice from such a committee/authority, it could shield the bank management from investigation by the three Cs (CBI, CVC, CAG) and this could expedite the decision. Is this enough to take public sector banks out of the fear psychosis that seems to be prevalent currently? Some assurance on the lines of what Deputy Governor Viral Acharya said at an IBA conference in February 2017 may be needed. To quote: “Haircuts taken by banks under a feasible plan would be required by government ruling as being acceptable by the vigilance authorities.”

Lopsided incentives

Another factor that impedes decisions in large NPAs is the concern that the existing provisions and capital may not allow the large haircuts needed to facilitate resolution, especially when it is not clear where the new capital would come from. Unless the Government simultaneously comes out with a capital plan for PSBs (including restructuring of banks) the resolution of large NPAs may prove difficult.

The present system of ownership and governance in PSBs has a lopsided incentive structure — there are pressures on bank managements to take on riskier exposures, for example in infrastructure financing — but when the exposures are under stress, there is no incentive to expedite resolution. On the other hand the fear of investigation inhibits decisions. It is not surprising that the bad loan problem is more of a PSB problem. Not that the large private sector banks do not face the problem, but they have a cushion in form of existing capital and capacity to raise new capital as well.

There is a clear regulatory conflict with the RBI’s role as regulator and supervisor if the RBI has to take a call on individual cases of bad loans. When even having an RBI nominee on the board of banks has been considered a conflict of interest, its intervention in individual cases of default puts the RBI in a very difficult position. There is a need for the RBI to distance its role as regulator/supervisor from the process to be put in place under the new ordinance.

Setting the parameters

It would be appropriate for the RBI to envisage the new authority under Section 35AB as an apex authority that lays down the broad parameters within which oversight committees that handle individual cases would function. The apex committee could have as members an eminent judge with knowledge of finance, seasoned former bankers, resolution experts, persons with relevant legal expertise and two persons from the RBI board not involved in regulation and supervision.

Given the number of cases for resolution and the time-frame, there would need to be three or four oversight committees with sector specialisation and persons having resolution expertise. The apex authority could formulate overarching guidance within which the oversight committees could function including laying down boundaries for haircuts, definition of sustainability or viability, period allowed for restructuring for different sectors, discount rates, etc. It could also advise on tweaking of the regulatory guidelines already issued by the RBI.

Even if it is accepted that in circumstances when the NPA issue threatens financial stability, there is need for RBI facilitation of the process of resolution in individual cases, there has to be a time limit for the new provisions in the ordinance. It needs to be understood that the measure is an unconventional one taken in the context of a situation that is threatening financial stability. The Government would do well to bring in or talk about a sunset or an exit clause to the new Sections 35 AA and AB of the Banking Regulation Act.

The writer was a deputy governor of the RBI. Via The Billion Press

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