Wednesday, April 9, 2014

Managing NPAs: Cure worse than the Disease

RBI started anew a failed initiative in an amplified form after a make-believe consultation document. Not all the perfumes of Arabia would clean the stench of INR 5trn. The SMA categorization for monitoring the stressed assets had its origin in 2002 itself.

But the moot question: is micromanagement going to be the solution that failed to impose a regulatory information system? The pressures on the senior Managers in attending the DLBCs, SLBCs and host of others would leave little time for the now introduced JLFs which in turn have to seek investors for stressed assets’ buy.

It is desirable that all accounts at different thresholds should be handled by a designated official for monitoring purposes and such number for the official should not exceed 25 for beyond Rs.500mn and 10 above this limit with responsibility for proper conduct and timely decisions on the account. Where the account requires internal committee decision for sanction, he shall convene the Committee and failure of this Committee to meet shall reach the CMD within less than 24 hours for resolution.

The sinking ship may get additional load for furthering the submersion with any upfront payment of cost of techno-economic feasibility study of restructuring. Instead, this can be done with the costs spread over the period of restructuring.

There is no need for further restructuring agreement or a binding commitment between the borrower and lender and the existing loan agreements shall be modified with one more clause added upon as a contingency clause or under Force Majeure.

The CDR process now announced has potential to extend to 210 days while the original loan may have been sanctioned within less than 30days of receipt of application!! What a regulatory wait for a borrower and lender to act upon irregular processes? Any CDR process in any segment cannot go beyond 60 days at worst and 30 days at best when alone the pressure would turn coal into a diamond. Since the borrower is known and the lender knows the movement of the account, the whole restructuring process with accountability fixed on either side should be capable of speeding up. I see the regulatory arbitrage in this timeline.

Imposing penalties will be opening new window for corruption unless they have transparent norms. In fact, a corresponding incentive in the restructuring process has potential for a careful CDR process


Credit origination has a significant contribution to the subsequent creation of NPAs. Dependence on systems has allowed permissiveness to the borrowers. The Directors of the Company Boards whose track records are taken for-granted lie at the core of the issue. The opinion on each individual director shall be part of the appraisal mechanism. The Director whose credit data is available now with the credit information companies, with default on any account shall be the first ground for fresh consideration of the proposal and also for seeking replacement of such Director before the credit proposal is considered. Next comes the question of the Management positioning and the CEO, CRO, CFO remuneration and perks having a bearing on operating costs. Third aspect relates to the industry environment which the banks are currently very efficiently doing till the first lap of credit-sanction. Post sanction, the environment should be on continuous inquest by the dedicated team at the Bank. There are outliers – pressures from external influences: could be from the Directors of the Board never on record, could be telephone calls from the Ministers – both State and Central – or from some other influential parties. They are like serpent under the grass. It never hisses but bites poisonously the sanctioning official. Now that this has largely been addressed to with a credit committee sanctioning the proposal, the teeth of the committee shall be protected by the CMD to insulate them from any consequence arising through rejection.

Loan Expos: The Banks those were chary of loan melas in the past now conduct by themselves without any political prodding and grant several home loans and other loans in retail segment in the Loan Expos. It is not possible for the most efficient institutional mechanism to complete due diligence process within 24 or 48 hours. For a money lender, it is possible to grant it in just an hour. The RBI should mandate halting mela processes if the objective is to contain NPAs.

Micro management unnecessary: The risks should be factored from time to time to see that the NPA is not created. Uncooperative borrower should be given the chit then itself. At source, the NPA can be halted thus. Only when the data on NPA comes to its gate it should ask for the compliance process to satisfy itself that due process of diligence has been followed by the Bank and yet the NPA surfaced.

In a dynamic and growth oriented economy, NPAs do occur in spite of every prudence and this should be given a treatment conducive to reducing their impact. The question at stake is the sharp distinction between the willful default and circumstantial default where the Banks have interpretative advantage.

Create Appropriate Reserve: A former top executive of the RBI who did his Ph.D., on NPA Management has some good suggestion. Sans the statistical models creation of a ‘PRECAUTIONARY MARGIN RESERVE’ (PMR) suggested by him starts with a small levy of 0.10 percent to 0.75 percent on the following mandatory classification of standard advances.

For this purpose the standard advances have been classified into four categories: A, B, C, and D for levy of PMR thus:
A category – Excellent: 0.10%; B-Very Good: 0.25%; C-Good: 0.50% and D-Satisfactory: 0.75%.
The classification depends on character, competence, and credit worthiness of the borrower based on market intelligence report from the responsible official entrusted with those advances and bank’s own experience; internal credit rating; and conduct of account.

The levy suggested should go to a Reserve as PMR Account in the General Ledger and should be shown in the bank’s balance sheet on the liability side. This should not be part of the normal “Reserves and Surplus’ account of the balance sheet of the Bank. The levy is akin to a guarantee fees with recourse by the bank. As this forms part of the ‘Disclosure of Accounting Practices’ under the ICAI rules of ‘Statements and Standards of Accounting’ and enabled by Section 5 (Ca) and 21 of the Banking Regulation Act 1949, as a prudent banking practice, there should be no legal objection for creating and operating the reserve.

In the case of off-balance sheet exposures like the Guarantees, LCs, forward exchange contracts etc., and the levy can be 1%.

This PMR shall attract bank rate for purpose of interest calculation or could be indexed to inflation with a base of 6% per annum. This Fund can be equated to subordinated debt thereby enabling the bank to save the interest cost and future recurring liabilities.

Since this forms part of cost of credit to the borrower, he would also be careful in performance. This does not lead to unnecessary lenders’ arbitrage or moral suasion.

Governments need not bail out banks on account of NPA accumulations as recourse to this Fund can be taken with the approval of the Board every quarter on critical examination of the NPA account. This Fund would also add to the strength of the Balance Sheet.

Incentives for CDR Compliance: This Fund can also be utilised to incentivize the system while disciplining both borrower and the lender simultaneously whereby a Restructured Debt performing to the estimated level of efficiency can be provided incentive in interest outgo and full reimbursement of the evaluation fees for the Techno-Economic Feasibility of Restructuring Package done initially. All infrastructure loans both of the public sector and under PPP mode should be factored for repayment at source like the TDS at the point of revenue accession.

Let the Audit Perform its job: The danger in blaming the audit and vigilance system to be under the new dispensation is missing the wood for the trees. Why the CAs who annually audit alone should take the blame when the whole system of audits perpetrate it? How these NPAs originated deserves to be looked at for making corrections instead of making a wild goose chase. Any such measure should not cut the roots of business growth in banks. The sword of accountability when it shifts from the criminal to the judge, the criminal has every opportunity to take advantage of and getting away with the ransom.

In fact banks' due diligence process took a beating with the arm chair and system based lending initiation. Banks would be well advised to go back to the basics to correct the malady instead of aping the western models of credit risk management. Any bureaucratization with the setting up of a JLC or the like would only open another window of opportunity for the lender and borrower a safe exit from shouldering their due responsibilities with impunity and this shall not happen. It can only add to the costs at different levels without any return. The borrowers get more time and escape routes to reach their destination of defaulting on the loans for ever.