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Managing NPAs...
At over Rs 2 lakh crore, the banking system’s NPA levels have got the government and the RBI worrying. There has been a spate of disparate yet connected pronouncements in this regard.

A proposal has come from the RBI seeking to cap bank’s large exposures to a single borrower group at 25 per cent of its tier-I capital (currently exposure could go as high as 55 per cent). In the same discussion paper it also seeks to wean corporates away from banks to debt markets: it believes these two measures will ‘de-risk’ bank balance sheets.

Next, SEBI announced regulatory relaxations (removal of SEBI pricing formula requirement and the 10 per cent cap) for converting stressed corporate debt to equity. Now RBI is expected to announce a Strategic Debt Restructuring scheme to help banks take over distressed listed firms.

These are well-intentioned measures that may help moderate NPA ratios, but do not address the core problem of NPAs, which is three-fold. The first is loss of  interest income.  The second is the need to make provisions out of already diminished pre-tax profits. And the last and  most important is the liquidity effect by choking cash flows especially considering the asset-liability mismatch (short liabilities and longer loan assets).

Exchanging debt for equity would not be any different from the exchange of SRs happening today with ARCs. Additionally, they could create other issues (viz., holding controlling stakes), which banks may be ill-equipped to handle.  Besides, a conversion would help only in the case of listed companies. There is no escaping the real solution to the problem, which is unlocking the cash from NPAs, either through recovery, close down or asset sales.


Driving corporates to bond market

The proposal to restrict bank’s large exposures and driving corporates to the bond market are interesting, inasmuch as they reveal RBI’s thought process for the future of banking. Indian banks are  largely risk averse, and the RBI paper itself admits that current average exposure levels at 14.75 per cent are far lower than the proposed 25 per cent cap. Therefore, this restriction is unlikely to have much impact on either banks or corporates. As to getting corporates to move to bond markets, the debt market (or the lack of it) has been a long played out theme in India. The absence of yield curves, the lack of transmission mechanisms, and regulatory issues (eg stamp duties) have been the reasons for the absence of a broad and deep debt market. There is virtually no secondary market and bulk of the subscription is by banks themselves. Thus, unless there is large retail interest forthcoming (as in the case of equities and mutual funds), corporate debt would still effectively get picked up only by banks.

Even granting this, what does this hold for banking? Does the RBI want banks to practise narrow banking (park deposits in government securities or corporate bonds)?  There is yet another important question.  With the level of NPAs as high as it is even with the rigour of stringent credit appraisal by banks, what can one expect from bond markets? The absence of secondary markets and the lack of rigorous risk assessment and transfer mechanisms could render bondholders vulnerable to delinquencies. It will be a tough act to get corporates  and banks away from the age old cash-credit financing (about 45 per cent of all credit outstanding) mechanism, which is a highly inefficient means that does not lend itself to credit discipline.


Equip banks to appraise credit needs better

While debt markets would be the way to go,  in the short run banks must equip themselves,  from an asset-liability perspective to meet credit needs emerging from sectors requiring massive investment. Reviving specialised long-term development financing institutions would be a good idea, but in the interim, credit delivery mechanism and project appraisal standards of banks would need vast improvements. The RBI has itself been critical of loan pricing followed by banks as being out of sync with ratings and has also frowned on credit processing being outsourced by banks.

Finally, considering that over 80 per cent of the NPAs are contributed by PSBs, owned by the government and regulated by RBI, it should not be the case that RBI holds itself responsible only for managing the base rate, leaving the risk premium to banks.

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