Loan revamp: Clubbing of sectors won’t help

A shrinking GDP, ending moratorium and a spreading pandemic — a perfect recipe for large-scale chaos especially in a country already struggling with falling growth rate and burgeoning public debt.

Amidst this setting, there was a need to quickly come up with a framework to delay the inevitable, large scale bad loans (NPAs). Every sector was crying for help, while the sector which was most affected, the banking sector, was considered to have the moral obligation to bail out businesses.

This view is completely oblivious of the fact that banks themselves are commercial enterprises with a fiduciary responsibility towards their small depositors and shareholders.

NPA worries

The total banking credit in the market is over $1.3 trillion and the RBI’s financial stability report estimated Gross NPAs rising to 14 per cent in the event of severe stress. Businesses were running out of orders and needed cash to stay afloat while banks refused lending fearing further bad loans. The RBI increased the spread between repo and reverse repo expecting banks to lend.

However they preferred to sit tight. with cash earning 3 per cent from the RBI while paying 5 per cent to depositors. But how long could this have continued without gradually destroying the wheels of the economy?

To solve the mess, the RBI appointed the KV Kamath Committee to suggest a framework for resolution of loans to affected sectors. The committee did a commendable job by submitting its report in a record 28 days. However, what was recommended as an indicative framework, giving businesses time till March 2023 and boards some headroom for discretion, came out as a fixed norm from the RBI (Circular dated September 7) with literally no flexibility for banks.

To put things in perspective, borrowers across 26 affected sectors, identified by the Committee, should achieve five specified ratios by March 31, 2022 (based on financial projections) to be even eligible for restructuring. A detailed analysis of the Circular shows why this may not solve the problem but only partially defer it till March 2022.

The accompanying Table shows that more than 70 per cent of the companies do not qualify for resolution even during better years of performance. The classification of the sectors was too broad based to provide targeted relief. For instance, all auto ancillaries were grouped under one head without giving importance to the industry to which they catered into.

While businesses catering to tractors had record quarters, those servicing commercial vehicles had probably their worst time in decades.

Multiple businesses with diverse models and capital outlays have been clubbed as a single sector. Hotels, restaurants and tourism businesses have been blended with common parameters prescribed for the sector as a whole, completely disregarding the fact that investment, scale and payback periods are entirely different.

Hotels are a real estate play and should have ideally been treated on a par with commercial real estate projects, with an enhanced Debt/EBIDTA of 12 instead of five which would have made the proposition palatable.

Another glaring case for concern is pooling businesses of all sizes and scale under the same sectoral category.

Commercial real estate is one sector which was deemed to be hit the hardest with WFH culture becoming an economical reality even post Covid. However, in reality, the large tech clientèle, of Grade A office spaces, have been paying rents regularly even during the lockdowns, while those severely hit are the malls and Grade B and C commercial property owners.

While the intention behind the Circular is laudable, the outcome may not solve the problem for most. Businesses must show extraordinary growth (at least in projections) to achieve the desired ratios by March 2022, for the sake of immediate resolution, however banks should brace up for a larger NPA crisis by March 2022.

The RBI would have done well to have accepted the recommendations of the Committee in both spirit and letter by giving flexibility to bank boards to take well-informed, micro-sector-specific decisions instead of a “one-size-fits-most guideline”.

The writer is Founder and Managing Partner, DVS Advisors LLP