We must approach NPAs differently

“We can choose status quo, but this would be insanity, ‘doing the same thing over and over again and expecting different results’ as Albert Einstein put it” — This is what the Reserve Bank of India’s deputy governor, Viral Acharya, reportedly said at a recent IBA awards function. He was referring to the intractable problems faced by Indian banks in resolving non-performing assets (NPA).

The new ordinance giving vast powers to the RBI to direct banks in quickly resolving NPAs and to appoint committee(s) to solve the problem seems to pursue the well-trodden path. However, there are some other approaches that can be tried.

The RBI had suggested various measures in the past to resolve the NPA problem, such as Corporate Debt Restructuring scheme (CDR), Corrective Action Plans (CAP), Joint Lenders’ Forum, 5/25 scheme, S4 scheme, etc. All these were issued without any special legislation. The RBI has enormous ‘persuasive powers’ to exercise over banks, especially those in the public sector. Two basic questions remain, however. One, should the RBI micromanage its regulated entities and two, somewhat irreverently, how valid is it to assume that RBI officials (with no expertise in granting commercial loans) can advise banks on NPAs?

Be that as it may, the total NPA of the banking system is reportedly over ₹7 lakh crore. A major portion seems to be in PSBs and about 50 borrowers belonging to infrastructure and construction, power, iron and steel, textiles and cement account for a bulk of NPAs in value. The following suggestions could be considered to revive the NPA borrowing units in these vitally important sectors of the economy, without unduly weakening the banking system: change the management of borrower’s business; try and ensure that the principal component of banks’ bad loans (after all concessions) is fully protected; and revise vigilance procedures and keep off CBI from pursuing civil liabilities.

The main reason for failure of businesses is the incompetence and/or dishonesty of management/promoters. As a first step, the lenders should change the management of the failed business. Legally, banks have the authority to do so. Section 13(4)(b) of the Sarfaesi Act vests full authority in banks to change the management of NPA borrowers after giving due notice; if there is more than one lender, those having 75 per cent (now reduced to 60 per cent) of the total secured debt should agree for the change. Section 15 further authorises the lending banks to appoint a new board of directors if the borrower is a limited company. It is also explicitly made clear that where such action is taken, the shareholders have no power to appoint/nominate any person as a director of the company. Banks should resort to this provision once a borrowal account is classified as ‘doubtful’, that is, it has defaulted in payment of interest/principal for a continuous period of 15 months. The new management could buy the unit outright or take it on lease for 10 years or so.

The second proposal is possible with some financial engineering. When a loan is ‘doubtful’, the RBI requires banks to provide for 30 per cent of the secured portion and 100 per cent of the unsecured portion. Since the tangible security in most of the big loans to businesses and industry would be considerably eroded by then, the provision would be easily around 50 per cent of the principal component of the loan.

In any revival plan either with the same promoters or others, banks should ensure that invariably at least 50 per cent of the loan is recovered over a period. One method known as the Brady Plan would require the borrower, lessee or new manager to deposit half the amount (25 per cent of the loan) in a Government of India bond fetching compound interest of 8 per cent (currently available) for nine years. At the end of that period, the principal would be doubled and the banks could recover 50 per cent of the principal component of the loan. Depending on the bargaining power, the lender could insist that the (new) borrower pays interest at a concessionary rate up to the full amount of the loan till the bond matures.

The last proposal has two aspects: internal vigilance and CBI enquiry. PSBs and many older private banks adopt the vigilance procedures applicable to government departments. Under these broadly, if a loan goes sour, all officials connected with the loan could be questioned and “accountability” fixed. Since such enquiries are done many years after the sanction, these tend to border on witch-hunt. The depressing effect of such procedures and the fear it generates was highlighted by the committee on banking reforms headed by M Narasimham, a former RBI governor, and even in World Bank reports. Successive governments have been oblivious to the plight of bankers in this regard.

Revising the vigilance manuals of banks to address the business of lending brooks no further delay. Would the Banks Board Bureau please initiate suitable action?

Lending to business and industry is always based on judgments about the future course of events: in a sense it is speculation. The future can never be predicted with accuracy. And mistakes could always be found in hindsight. Since borrowing and lending are civil actions, the CBI should not be asked to decide on the merits of a lending decision at a future date. Having said that, the CBI is well within its rights to go after dishonest bankers; obviously it would be impossible to identify and prosecute every banker who deviates from the path. And even with all the elaborate vigilance procedures, there were reports of a few chairmen of banks — private and public — being booked for dishonesty in the past two decades. Therefore, the CBI’s limited valuable resource should be used in screening people who are to be appointed to the post of MD/ED.

In doing so, the CBI could make discreet enquiries from bank officers reporting to the promotee; this would certainly be authentic and serve the purpose. It could well be asked as to what should be the role of the Centre and the RBI in resolving the humongous problem of NPAs. The Centre, as the owner of PSBs, and RBI as regulator, should ask all PSB heads to commit that the gross NPA percentage would be reduced by around 25 per cent in the first three quarters of FY 2017-18 and have the progress monitored by their representatives on the board. Depending on the outcome, further similar action could be taken. Nowhere in the advanced countries do the government and regulator micromanage banks (even those in public sector). Is it too much to expect the Centre and the RBI to follow these best practices?

The writer retired as Deputy MD of SBI