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Time to walk the talk

The RBI has to conduct regular audits to prevent another bout of crony capitalism that can further damage the balance sheets of the banks


AFTER Swachh Bharat, it is now time for Operation Swachh Banks. The Reserve Bank of India (RBI) has initiated a massive nation-wide campaign to clean up the balance sheets of banks, especially the state-owned ones, which are saddled with huge amounts of bad loans, or NPAs (Non-Performing Assets). On the hopeful side, which is loudly cheered by the social media, are the banks’ efforts to sell the assets of wealthy business persons, who flaunted their money and luxury assets, but whose companies failed to repay their loans…again and again and again.

The name of this game is shame. The idea is to recover whatever money the bank can because the companies cannot repay and, in the process, make the entrepreneurs go through public disgrace. In addition, a few banks like the Punjab National Bank (PNB) publicise the names of the ‘willful defaulters’, that is borrowers who can repay but don’t. Legally, their loans haven’t been declared as NPAs and written off, that is, they will never be repaid. In its latest list, the PNB claimed that it had 904 willful defaulters, and they owed almost Rs. 11,000 crore to the bank.

On the pessimistic side, the central bank forced the banks to truthfully reveal their NPAs, and not hide them, and adjust it against their profits. In the last quarter results, several public sector banks incurred huge losses, or witnessed huge dips in profits because of this pressure. For instance, in its October-December 2015 quarter, the State Bank of India kept aside almost Rs. 8,000 crore as ‘contingencies’, almost double the previous allocation. The bank’s profits plummetted to just over Rs. 1,100 crore in the December quarter, a 70 per cent slump from the previous one.

Several experts praise Raghuram Rajan, RBI Governor, for the manner in which he has twisted the banks’ arms to force them to clean up their balance sheets. They are excited about the powers granted to the banks to convert their loans into equity, become majority shareholders in companies whose loans became bad, and either sell off the assets or effect management changes later. In the case of the Vijay Mallya-owned Kingfisher Airlines, a consortium of banks and other stakeholders have begun to sell Kingfisher’s assets, which include aircraft and real estate.

Others feel that Rajan has gone overboard. The process can weaken the banks and many of them can go under. Since the government will not allow this to happen, it will merge the weak banks with the strong ones, a move that will impact the banks whose balance sheets are robust. These analysts think that the central bank needs to treat each case separately to see which are the serious businesspersons, who have inadvertently got into trouble, and those who deliberately took the wrong decisions. One shoe and one rule cannot fit all.

More importantly, the initiatives to improve the banking sector, which is saddled with bad loans of 6.6 per cent of their overall loan portfolio, estimated Credit Suisse, are lopsided. Experts contend that un-provided NPAs are 30-75 per cent of the capital of state-owned banks, and un-provided stressed loans, which may turn bad soon, even higher at 65-200 per cent. This implies that the banks will need a huge infusion of cash by 2017 and this will pressure government expenditure and impact the annual fiscal deficits in the near future. The situation will turn worse before it goes out of gear, if Rajan and Co. don’t change their approaches and mindsets soon.

Why target only big defaulters?
Whether it is the RBI, the finance ministry and the banks, the talk is invariably about how to deal with the NPAs of large companies, or those who have enormous personal wealth but allow their companies to incur huge losses through gross mismanagement. Thus, the focus is always on individuals like Mallya, who flaunt their personal aircraft, yacht, and beach houses, but throw up their hands when it comes to paying back the banks’ loans. So, they become the target of anger, and quite legitimately too. But this is like capturing only half the picture, which can lead to problems.

The banks need to target all the willful defaulters and even those companies or individuals whose loans are likely to turn bad in the near future. There is no place for discrimination for several reasons. One, the amounts owed by small and medium businesses are substantial, as is evident from the PNB’s latest list of willful defaulters. None of them falls into the ‘big business’ category. Most of them are little-known players, but the amounts they owe to the bank are in hundreds of crores of rupees. Most important, it is easier to pressure them, rather than large businessmen.

Several experts praise Raghuram Rajan, RBI Governor, for the manner in which he has twisted the banks’ arms to force them to clean up their balance sheets. Others feel that Rajan has gone overboard. The process can weaken the banks and many of them can go under

THIS change of focus is critical once the government, as promised, introduces a Bankruptcy Act in Parliament. This, claimed Finance Minister Arun Jaitley, would allow companies to shut down easily, and enable the lenders to easily initiate a process to recover their monies. However, as experiences from developed nations prove, small and medium businesses are generally keener to declare bankruptcy. Hence, the banks need to focus on large as well as other businesses, so that they can take corrective and proactive actions in cases of bankruptcy.

Change in management
Last year, the RBI allowed banks to convert their loans into equity, hike their combined stakes in a defaulter company to 51 per cent, and take over the management. Unfortunately, there are several caveats that may hinder the use of this power. One, it applies only to new loans that may go bad in the future, and not to the existing stressed loans. The only window of opportunity for existing debt is if there is a provision to do a debt-equity swap in the original loan agreements. Thus, the banks can use this power for the fresh loans that they give now.

An alarming position

1. 27 state-owned banks have written off `2.77 lakh crore ($1 billion) of bad loans in the last 10 years.
2. Out of this, `1.14 lakh crore ($16.8 billion), or 40 per cent, of the total bad loans were written off during the last three years over FY 2012-15.
3. A further `52,227 crore is expected to be written off in FY16 (India Ratings report).
4. This would take up the total bad loans to `3.29 lakh crore ($48 billion).
5. The proportion of stressed assets surged to 17 per cent for public sector banks while for private banks it is 6.7 per cent and for foreign lenders, 5.8 per cent, as of September 2015. So the PSU banks’ asset quality is the
worst amongst the lot (almost three times worse than their peers).
6. Among the BRICS (Brazil, Russia, India, China, South Africa), India’s NPA rate is the second highest after Russia, and this year it may surpass Russia to top the list.

Two, most bankers feel that the banks have no expertise to manage companies. They can assess businesses, become the watchdogs and insist on corporate transparency, but their managers don’t possess entrepreneurial, leadership and managerial skills. Hence, even if they own a majority in a stressed company, they will need to find the right managers to run it. This is not an easy task; moreover, it is time-consuming and can hurt the financials of the company even more. Whenever lenders have taken over companies, they have largely failed because of their attention on how to get their money back rather than how to put the company back
on track.

THREE, it is counter-intuitive to realise that it is not easy to sell a company which is already in trouble. And when it is apparent that the lenders are desperate to sell to recover their monies, the offer price is likely to be hugely discounted, and much below the market price. Most contend that taking over a company and finding a lucrative buyer is tough, and may suck off crucial management bandwidth of the banks. It may turn out to be an impractical proposition.

The RBI has to realise that, while it may be good for it to play the carrot-and-stick policy, the banks can use the central bank’s lollipops to hide their stressed debt. This has happened, and is happening, with the Corporate Debt Restructuring (CDR) scheme

Public sale of assets
The same is true of sale of assets of companies that have defaulted. Potential buyers know that the lenders are desperate to sell, so they offer low prices unless they are keen to buy. Experiences show that normally the lenders are unable to extract the market prices, and they are happy that they do get some money back. In the case of Kingfisher, one of its planes was sold as metal scrap in pieces and was purchased by a scrap dealer. This shows that if there are delays in the sale of assets—generally because no one ups the floor prices—the assets lose value really fast.

So, it is a Catch-22 situation for the lenders. They have to act fast, correctly estimate what the market will pay, and then conduct the auction quickly. In most cases, this doesn’t happen because of the lack of expertise within the banks and the inherent bureaucracies that delay the process. For example, it took over three years for the consortium led by SBI to merely take over Kingfisher’s Mumbai property and put it on the auction block.

Thus, the bankers need to adopt a comprehensive approach—convert debt into equity if they can do so, acquire majority stakes, effect management (not ownership) change, that is, they get in a new team to manage the company and not sell their combined stakes, change the fortunes of the company, and then either recover their loans or get the new management to sell the assets, either piecemeal or through a stake sale deal. For this, the banks have to get in experts.

One of the options is to tie up with a slew of private equity players or investor-consultants, whose job is to take over managements and turn-around firms. There are several local and global players who do this efficiently and also hike the value of the assets over a short period. They can then help the bankers to sell the assets within a few years. America, in the 1980s, was full of management experts who conducted leveraged buyouts and made huge sums when they finally sold the assets.

Policy loopholes
The RBI has to realise that, while it may be good for it to play the carrot-and-stick policy, the banks can use the central bank’s lollipops to hide their stressed debt. This has happened, and is happening, with the Corporate Debt Restructuring (CDR) scheme. It had the right intentions to allow companies that got into financial troubles because of external reasons the leeway to get out of their binds. But the bankers and businesspersons, with political support, got together to protect the potential defaulters. One of the biggest beneficiaries of CDRs was Mallya. Then the RBI allowed banks to roll over loans given by high gestation period infrastructure after every five years to another bank or consortium. The logic was simple: banks lend to projects that make money after years, and if something goes wrong like unexpected delays, the money gets stuck. The roll-over enables the bank to treat it as fresh loans, which can only go bad after a few years. Obviously, this became a convenient way for the banks to help businesses. The RBI needs to monitor each such roll-over deal that happens in the future to prevent blunders.

What needs to be probed

1. Is this another coal/2G scam in the making? Have corporate houses benefitted from this largesse in the same way as in the coal and spectrum allocation scams? The amount of loss, Rs. 3.29 lakh crore, so far is much more than the Rs. 1.86 lakh crore in the case of the coal scam and Rs. 2 lakh crore in the 2G scam. Further, this is actual loss and not opportunity loss as in the case of the coal and 2G scams.

2. How much of the above loans were secured? What efforts were made to recover money owed through sale of such security and how much was recovered?

3. Were proper rules followed while disbursing and monitoring these loans? Have rules been flouted to help promoters siphon off taxpayers’ money? Or, were bank officials hand-in-glove? The Bhushan Steel-Syndicate Bank case and the Central Vigilance Commissioner (CVC) recommending action against officials of 26 banks, which together provided Rs. 2,650 crore to Zoom Developers, are pointers to the fact. There have been glaring instances of diversion of funds to unrelated businesses and frauds.

4. How and why has such a huge pile of bad loans accrued in the system? How much of it can be attributed to the economic downturn? How much of it has happened due to regulatory aspects/loopholes?

5. What about fixing responsibility? Is it big and powerful promoters who use system loopholes to their advantage, at times with active political patronage, or the unprofessional and callous public sector bank managements? Should the naming and shaming of scrupulous and willful defaulters not be done?

6. Are our banks adequately equipped with technical expertise, policy implementation and coordinated efforts within themselves? Promoters often inflate value of security or collateral offered to cover their part of the equity, making the projects more risky from inception and banks indirectly finance such equity. This also leads to much lower recovery in the event of default. The government-owned banks neither have a standard risk assessment mechanism nor any coordination and credit information exchange amongst themselves; the result is that a loan rejected by one bank is passed by another. Bank officials of the public sector banks lack technical expertise and skills and there is a huge gap between pay packages of private banks compared to public sector banks that hampers in attracting good talent.

EVEN the latest policies that the lenders can take over management and sell the assets of NPA firms can be, and is being, misused and manipulated. The RBI has recently warned that the banks have to carefully check the backgrounds and antecedents of the buyers. The reason: there were cases when the original owners, who defaulted on the loans, bought their own assets through front and benami companies. Thus, they got the assets back at a discount, and were rid of the loans too. This can even happen in cases of management takeovers. The banks cannot prevent them; more important, like in the past, some of the errant banks can act together with the corporates.

Clearly, tackling NPAs and stressed loans isn’t easy. Banks have restricted skills and cannot manage companies or sell assets. They need to form a panel of individuals and specialist firms that can help the lenders to achieve their objectives. In addition, the central bank has to keep an eye on the banks and conduct regular audits to prevent another bout of crony capitalism that can further damage the balance sheets of the banks. Rajan’s job has only just begun. He has spoken, now he has to act.

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