Sunday, August 21, 2016

India banking sector - a long road ahead

Livemint has this assessment of the Strategic Debt Restructuring (SDR) scheme initiated by the Reserve Bank of India (RBI) last year to address the issue of bad bank loans,
In the 14 months since it has been introduced, banks have invoked the provisions of SDR in at least 21 cases... they have converted debt to equity in only four cases... Of these, they have closed out only two. Difficulties in finding buyers, disagreement over valuations and even the choice of merchant bankers used in the SDR process seem to be impeding closure... some of the probable buyers that came on board eventually exited due to creditors’ concerns around their genuineness and source of funding, among others... In most of these deals, the banks are required to take a serious haircut, which is something that they are not interested in.
The SDR entailed converting debt to equity, taking over management, and finding a buyer in 18 months, failing which the asset became classified as a Non-Performing Asset (NPA) with all requisite provisioning requirements. As if acknowledging its failure, in June, the RBI introduced another scheme, the Scheme for Sustainable Structuring of Stressed Assets (S4A), which allowed banks to convert up to 50% of debt into equity without the need to find buyers immediately.

This problem does not have any immediate and easy solutions. Given the size of the NPAs, Rs 6.3 trillion as of end-June, and more likely to be much higher, there are at least two binding constraints on both supply and demand sides. On the supply-side, as mentioned, the banks are clearly unwilling for various reasons, the vigilance enquiry concerns being primary, to take anything close to the reasonable haircuts required to make such assets attractive to buyers. Given the persistent global economic weakness and related uncertainties, as well as the risks associated with restructuring such assets, it is not surprising that investors demand very high haircuts. In any case, the valuations of many of these assets are far below their liabilities. On the demand-side, the market is too narrow, in fact by orders of magnitude, to absorb these assets. Apart from the finances, the human resource and corporate capital available to manage and restore the health of bad assets too is acutely scarce. And neither of these can be addressed soon.

Apart from this, there are several other operational challenges - incentive compatibility problems with Asset Reconstruction Companies (ARCs) and the Security Receipts (SRs) issuance processes; continuing linkages between banks and the assets sold to ARCs; practical difficulties associated with consolidation of fragmented debt; and problems with taking over management control and bankruptcy resolution. Complicating matters, the considerable risk of corrupt practices in transactions, engendered by the poor corporate governance standards and lack of market competition, forces the RBI into more tougher regulations, which in turn limits the sale prospects further.

In the circumstances, the best that can be done is a mix of different options. One, continue the ARC and leveraged buyout fund routes. Two, encourage purchases by private (infrastructure funds) and public (like NIIF, IIFCL etc) funds which could either securitize some assets or establish SPVs and manage these assets till they become profitable. Three, strategic acquisitions of some of the infrastructure assets, especially in power, by the better governed public sector units. Four, strategic auction of certain other assets, especially in steel and metals, to reputed private buyers. In at least some of these cases, provisions like back-ended clawback of some share of windfall gains by potential buyers may ease the resistance and apprehensions associated with such sales. 

In order to facilitate this process, to start with, it would be useful to classify the NPA loans into different categories based on the nature of loans and the types of buyers who are likely to be interested. For example, retail loans like mortgages, credit card, and other small enterprise and personal loans can be classified into one category, which can be sold off in plain vanilla auctions. The infrastructure loans can be classified into completed cash-flow generating projects (strategic sales), incomplete public goods (strategic acquisitions with public leverage), and incomplete private projects like steel plants (restructured disposal). It may also be useful to make available to potential investors the portfolio of such assets so as kindle the interest of the biggest global asset managers and pension and insurance funds. Or even bundle similar assets so as to make them attractive to buyers with deep pockets and patient capital. 

None of these are simple and are certain to throw up challenges and uncertainties. It is, therefore, essential that the restructuring embraces at least three principles. One, it will be necessary to let enabling regulations emerge as the process unfolds. Two, there will have to be a high level of tolerance for omissions and oversights (which are likely to become egregious with the benefit of hindsight) and failures. Finally, avoid the attractions of quick-fix solutions and prepare for the long haul. A mix of restructuring and restoration by economic growth, played out over a period of time, may be the most prudent strategy. 

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