Friday, November 17, 2017

Recapitalisation, NPAs and Basel III



Post demonetisation, banks were flush with funds and yet credit did not pick up. Blame was on the surging NPAs that decimated the risk appetite of the Banks. The whole country is now aware that NPAs of corporate borrowers is the villain of the piece. Banks for once stopped blaming the priority sector for the unsustainable level of NPAs.

PSBs have their liberal share and therefore FM announced recapitalization of the order never seen before at Rs.2.11trillion. To call these reforms is a travesty of judgement. Average tax paying person has to bite the bullet. It has the potential for moral hazard.




Virtually there would be no lending institution in the globe that can claim nil NPAs. World Bank Development Report has recently published the non-performing loans as percentage of total loans. 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. Global economic pressures, inflation and policy drifts in the domestic economy make their liberal contribution and the solution lies with the vigilant banks.

According to World Bank Data relating to percentage of non-performing loans to total loans (https://data.worldbank.org/indicator/FB.AST.NPER.ZS) Greece takes the topmost slot with 36% NPA ratio while the next closest is rest of South Asia with India in the close ten-digit league. High income economies fared significantly better barring the recession battered years during the last 15 years. Countries that received aid from international agencies have high NPA ratio with Europe and Central Asia no exception. India that performed well on this front till 2012 deteriorated year after year. Risks of loss resulting from inadequate or failed internal processes, people and systems, broadly classified as operational risks enhanced. Strategic and reputational risks also increased with Mallyas-like surfacing and just 12 corporate undertakings contributing to more than a third of the total bad debts.

Regulator says that it has been doing all that it could to tame the shrew, like corporate debt restructuring (CDR), special treatment to the Special Mention Accounts (SMA), clean-up of balance sheets, higher provisioning norms during Raghuram Rajan regime as Governor, RBI, etc.

Yet, Financial Stability Report (2017) mentioned that ‘the banking stability indicator worsened between September 2016 and March 2017 due to deterioration in asset quality and profitability,’ notwithstanding the strong fundamentals of the macro economy. Financial stability has critical influence on price stability and sustained growth. It facilitates efficient transmission of monetary policy actions. More importantly, it safeguards the depositors’ interests and ensures the stability of the financial system.

While the lately introduced Insolvency Bankruptcy Code has a potential of success, it has no immediate consequence to remedy the situation and even the recent amendments to the code will have to wait for results to happen at least for a year as the resolution process itself has in-built mechanism to extend for 270days.

While the owner has all the responsibility to refurbish the capital, there is demonstrated failure on the part of Government of India performing the dual role of regulator and owner in taking timely corrective measures. The owner is blindfold to the reality. Ever since universal banking has been introduced, collateral damage has been done with the sale of non-banking products like insurance, mutual funds with banks incentivizing the staff for such effort, taking preference over the traditional banking products, viz., deposits and credit. Due diligence of firms, their partners, directors has become a casualty.
Exposure norms have been redefined.
Exposure Norms for Commercial Banks
Exposure to
Limit
1, Single borrower
2. Group Borrowers
3. NBFC
4. NBFC-AFC
5. Indian Joint venture /wholly owned subsidiaries abroad/overseas step down subsidiaries of Indian corporates
15% of capital fund (Additional 5% on infrastructural component)
40% of capital fund (Additional 10% on infrastructure exposure)
10% on capital fund
15% on capital fund
20% on capital fund
6. Capital Market Exposure
(a)   Banks holding shares in any Co.
(b)  Banks’ aggregate exposure (solo basis)
(c)   Group basis
(d)  Banks’ direct exposure (solo)
(e)   Banks’ direct exposure (group)
(f)   Gross holding of capital among banks/FIIs
The lesser of 30% of paid up share capital of the Co., or 30% of the paid up cap of banks
40% of its net worth
40% of its consolidated net worth
20% of net worth
20% of net worth
10% of capital fund

On the basis of the redefined Expected Loss calculations under Basel III regulations, PSBs in India require capital infusion of a near Rs.5trillion due to their level of NPAs standing at over Rs.7trn as at the end of FY 2017. Indian Banks thus had adequate warning to comply with additional capital requirements by 1st April 2018.  

Narasimham Committee advised the Union Government to wind up department of banking as it lacks professional competence to direct the industry apart from duplication of regulatory and supervision functions. Till date this has not been done. It infested Bank Boards with officials of the Finance Department whose performance was never on the radar for inquest. Second, RBI as regulator has no business to represent on the Boards and yet it continued. If such presence could have contributed to efficient performance of the banks it was a different matter. Unfortunately, successive governors had done little to correct the situation.

The recipe for the malady suggested by one of the researchers from the RBI to set up “Precautionary Marginal Reserve Fund” went into deaf ears.

It starts with a small levy of 0.10 percent to 0.75 percent on the standard advances. For this purpose the standard advances have to be classified into four categories:
A category – Excellent: 0.10%; B-Very Good: 0.25%; C-Good: 0.50% and D-Satisfactory: 0.75% for levy. The levy on off-balance sheet exposures like guarantees, LCs could be 1%.
“The classification into A, B, C, D has to be done on a scientific basis ensuring inter alia, continuous relationship between the borrower and lender and transparency in their dealings.”

Character, competence, 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 should be the parameters for classification.

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.

This PMR shall attract bank rate for purpose of interest calculation or could be indexed to inflation with a base of 4% per annum. By equating this to subordinated debt, interest cost and future recurring liabilities can be saved.

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.’

Repayments at Source for Infrastructure Loans also makes lot of sense. When we have a good payments and settlements mechanism, we can integrate the service providers of the High Ways, Telecoms, and Power Distribution companies with those of the Banks for deduction at source of consumer payments for those services.

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.

It’s no use crying over spilt milk. All is not lost. Government can at least now take the following measures now that it is also part of the Financial Stability Board. First and foremost, divest its role from supervising the PSBs and let the autonomy prevail with them to make them accountable to do what is in the best interests of the institution. Second, let the Bank Board Bureau develop a pool of directors qualifying to be on Bank Boards. Each such director should be asked to furnish a statement of his possible contribution on the Board that should be the basis of assessing his/her performance in addition to the non-disclosure agreement. RBI should likewise withdraw all its nominees on the Boards of Banks. Third and most important, Government and RBI should reverse universal banking and disallow cross-selling non-banking products. Fourth, RBI should direct the banks to set up the Precautionary Marginal Reserve Fund to tackle the NPAs effectively. As an immediate interim measure, PSBs should be enjoined upon to withdraw all incentives to staff for such cross-sale. Let the salaries and pensions of bank staff move in tandem with the 7th Pay Commissions’ recommendations. Pay and perks of the top executives of PSBs should be no less than their private peers. Recapitalisation of banks of the order now envisaged is a necessary evil in the context of G-20 and Basel III commitments but will make sense when banks do banking.




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