The suggested timeline of 210 days for CDR has potential for misuse, especially when the original loan may have been sanctioned within less than 30 days. This will only give defaulters more time and escape route

The Reserve Bank of India (RBI)’s draft paper on ‘Revitalising Stressed Assets in the Economy’ reflects its anxiety and agony over the mounting non-performing assets (NPAs) in the banks during the last decade. It also reflects the failure of management information system (MIS) introduced in banks through its circular of 2002 referred in the draft. The ‘Special Mention Accounts’ (SMA) concept has come into existence in 2002 and yet there has not been any feed back as to how this concept is performing in practice. If we were to go by the mounting NPAs, obviously this concept did not work. And yet, the RBI choosing to work its strategy on this concept is opening another window for delay and procrastination.

Bank managers and top executives have acute pressure on their time due to a number of committee meetings they have to attend from the District Level Consultative Committees (DLCCs) to Securities Lending and Repo Committee (SLRC) and State Level Inter-Institutional Committee (SLIC) and many more. In fact, consortium lending of the past to corporate sector had to take a different format because the consortium did not arrive at consensus on the modalities and sanctions in time. The Joint Liability Committee (JLC) now suggested, will be another bureaucratic intervention ending as a cropper. Bankers’ other essential preoccupations do not allow the Joint Lenders' Forum (JLF) to scout for investors. On the other hand, it is desirable that all accounts at different thresholds should be handled by a designated official for monitoring purposes and such number for the official should not exceed 25 for beyond Rs50 crore and 10 above this limit. He shall be held responsible for the proper conduct of the account and timely decisions on the account.

The sinking ship may get additional load for furthering the submersion with any upfront payment of cost of techno-economic feasibility study of restructuring. Instead, this can be done with the costs spread over the period of restructuring.

There is no need for further restructuring agreement or a binding commitment between the borrower and lender and the existing loan agreements shall be modified with one more clause added upon as a contingency clause or under Force Majeure.

The corporate debt restructuring (CDR) process in the draft proposals has potential to extend to 210 days while the original loan may have been sanctioned within less than 30 days of receipt of application! What a regulatory wait for a borrower and lender to act upon irregular processes? Any CDR process in any segment cannot go beyond 60 days at worst and 30 days at best when the pressure alone would turn coal into a diamond. The suggested timeline has potential for regulatory arbitrage. Imposing penalties will be opening new window for corruption. On the other hand, every penalty has to have a corresponding incentive in the restructuring process. It is the gross NPAs that require attention. Nipping them in the bud makes lot of sense.

Micro management unnecessary: The risks should be factored from time to time to see that the NPA is not created. Here the cooperation of the borrower is imminent. An uncooperative borrower should be given the chit then itself. At source, the NPA can be halted thus. This micro management is unnecessary for the RBI. But when the data on NPA comes to its gate it should ask for the above compliance process and satisfy to itself that due process of diligence has been followed by the bank and yet the NPA surfaced. In a dynamic and growth oriented economy, NPAs do occur in spite of every prudence and this should be given a treatment conducive to reducing their impact.

Credit origination has a significant contribution to the subsequent creation of NPAs and these needs to be looked into. The first suggestion to bankers is that they should go beyond the system. The three ‘E’s, enterprise, entrepreneur and environment’ in the credit risk assessment have lately been addressed through a system. This has allowed permissiveness to the borrowers. The directors on company board whose track records are taken for-granted lie at the core of the issue. The opinion on each individual director shall be part of the appraisal mechanism. The director whose credit data is available now with the credit information companies, with default on any account shall be the first ground for fresh consideration of the proposal. If the company does not substitute that director(s) the loan proposal should be rejected outright. Only when the enterprise is worthy of consideration the question of the management positioning and the chief executive (CEO) or operating officer (COO) and finance officer (CFO) of the company comes into picture. Their credentials need be examined thoroughly and their remunerations vis-à-vis the projections in operating costs needs examination and inquest. Third aspect relates to the industry environment which the banks are currently very efficiently doing till the first lap of credit is sanctioned. After the loan is sanctioned and disbursed, the environment should be on continuous inquest by the dedicated team at the Bank. There are outliers – pressures from external influences: could be from the directors of the board never on record, could be telephone calls from the ministers – both state and central – or from some other influential parties. They are like serpent under the grass. It never hisses but bites poisonously the sanctioning official. Now that this has largely been addressed to with a credit committee sanctioning the proposal, the teeth of the committee shall be protected by the chairman and managing director (CMD) to insulate them from any consequence arising through rejection.

Loan Expos: Those banks that were wary of loan melas in the past now conduct it without any political prodding and grant several home and other loans in retail segment in these expos. It is not possible for the most efficient institutional mechanism to complete due diligence process within 24 or 48 hours. For a money lender, it is possible to grant it in just an hour. The RBI should mandate such processes if the objective is to contain NPAs.

Default Inquest: Here comes the question of wilful neglect and circumstantial default. The former should be dealt with firmly by instituting legal process while the later should be done with a responsible and responsive dialogue between the lender and borrower. The package here should be one of penalties and incentives.

Create Appropriate Reserve: It is at this point comes the most ‘valuable’ suggestion of Dr TV Gopalakrishnan, former executive of RBI. Sans the statistical models, creation of a ‘Precautionary Margin Reserve’ (PMR) suggested by him makes lot of sense. It starts with a small levy of 0.10% to 0.75% on the standard advances. For this purpose the standard advances have been classified into four categories:

A category – Excellent: 0.10%

B-Very Good: 0.25%;

C-Good: 0.50% and

D-Satisfactory: 0.75% for levy

“The classification into A, B, C, D has to be done on a scientific basis ensuring inter alia, continuous relationship between the borrower and lender and transparency in their dealings.”

All standard advances at the end of the financial year have to be classified mandatorily into the above four categories strictly on the basis of performance of the borrower on the following parameters: character, competence, credit worthiness of the borrower based on market intelligence report from the responsible official entrusted with those advances and bank’s own experience; internal credit rating; and conduct of account.

The levy suggested should go to preventive measures reserve (PMR) account in the general ledger and should be shown in the bank’s balance sheet on the liability side. This should not be part of the normal “reserves and surplus’ account of the balance sheet of the bank. The levy is akin to a guarantee fees with recourse by the bank. As this forms part of the ‘disclosure of accounting practices’ under the Institute of Cost Accountants of India (ICAI) rules of ‘Statements and Standards of Accounting’ and enabled by Section 5 (Ca) and 21 of the Banking Regulation Act 1949, as a prudent banking practice,  there should be no legal objection for creating and operating the reserve.

In the case of off-balance sheet exposures like the guarantees, letters of credit (LCs) and forward exchange contracts and the levy can be 1%.

This PMR shall attract bank rate for purpose of interest calculation or could be indexed to inflation with a base of 6% per annum.

This Fund can be equated to subordinated debt thereby enabling the bank to save the interest cost and future recurring liabilities.

Since this forms part of cost of credit to the borrower, he would also be careful in performance. This does not lead to unnecessary lenders’ arbitrage or moral suasion.

Governments need not bail out banks on account of NPA accumulations as recourse to this Fund can be taken with the approval of the Board every quarter on critical examination of the NPA account. This Fund would also add to the strength of the balance sheet.

Incentives for CDR Compliance: I would also suggest that this Fund can also be utilised to incentivize the system whereby a restructured debt performing to the estimated level of efficiency can be provided incentive in interest outgo and full reimbursement of the evaluation fees for the techno-economic feasibility of restructuring package done initially.

This scheme would impose discipline both on the borrower and lender eventually.

Repayment at source for infrastructure loans also makes lot of sense. When we have a good payments and settlements mechanism, we can integrate the service providers of the highways, telecoms, and power distribution companies with those of the banks for deduction at source of consumer payments for those services as suggested by another veteran banker.

Let the audit perform its job: The danger in blaming the audit and vigilance system to be under the new dispensation is missing the wood for the trees. Why the chartered accounts (CAs) who annually audit alone should take the blame when the whole system of audits perpetrates it? How these NPAs originated deserves to be looked at for making corrections instead of making a wild goose chase. Any such measure should not cut the roots of business growth in banks. The sword of accountability when it shifts from the criminal to the judge, the criminal has every opportunity to take advantage of and getting away with the ransom.

Conclusion:

In fact banks' due diligence process took a beating with the arm chair and system based lending initiation. Banks would be well advised to go back to the basics to correct the malady instead of aping the western models of credit risk management. Any bureaucratisation with the setting up of a JLC or the like would open another window of opportunity for the lender and borrower a safe exit from shouldering their due responsibilities with impunity and this shall not happen. It can only add to the costs at different levels without any return. The borrowers get more time and escape routes to reach their destination of defaulting loans for ever.

(B Yerram Raju is an economist and risk professional)