It’s been two painful years since India embarked on an attempt to clean up the balance sheets of its banks. Until 2015, banks were pretending that all was well, but pretty much everyone knew that it wasn’t.
At some point that year, the Reserve Bank of India in consultation with the government, decided that the country’s banks must be cleaned up.
Step 1 was an asset quality review. This forced banks to recognise stressed assets. The result was a jump in gross non-performing assets from Rs 3.4 lakh crore in September 2015 to Rs 8.4 lakh crore now. While the RBI was focused on the clean-up, the government pushed through a modern Insolvency and Bankruptcy Code which was operationalised in 2016.
Then came step 2. The surge in bad loans meant that banks, mostly government owned, were short on capital. The shortage of capital meant that banks were delaying provisioning for stressed assets. After a seemingly endless delay, the government announced a massive Rs 2.11 lakh crore recapitalisation package last month.
Through an amendment to the Insolvency and Bankruptcy Code, the government essentially barred a majority of the defaulting promoters from buying back their assets.
A small window was provided for those who may be able to make good on their overdues. If promoters can regularise the account by paying the overdue amount before the resolution process begins, they may be able participate in the bidding process.
With that one clean sweep, the government pushed up the credibility of India’s bad loan clean-up. The amendments (unless they are diluted) will have far-reaching implications for banks. Not all positive, but certainly worth it.
To understand the repercussions of this on banks, it is important to look at the nature of these assets. More than half of them are in the steel sector while the others fall in power and infrastructure. One is an auto component firm.
The steel assets are being bid out at a time when the steel price cycle has turned. While economic growth isn’t at its peak, it is expected to pick up from here.
If at this stage in the cycle, a steel asset comes up for bidding, investors will probably not look away. Indeed that appears to be the case. As BloombergQuint has reported, both international and domestic steel firms have expressed interest in the steel assets that are being resolved through insolvency.
To be sure, this is not necessarily the case for assets in the power and infrastructure sector where interest may be lower. As such assets could either be resolved at throwaway prices or, in a few cases, left for liquidation. In such cases, banks may take a bigger hit but remember they have already provided a fair amount against these assets.
The bidding dynamics, and the implications for bank balance sheets, will become clearer over the next few weeks and months. What is clear immediately is the signalling effect of the government's decision.
Firstly, bankers will no longer need to worry about whether they would be questioned on their decision to either award or deny an asset to an erstwhile promoter.
The implications go beyond the immediate set of insolvent assets. With an unforgiving insolvency law in place, promoters of firms who are on the verge of default will know not to mess with the system. Those who can sell assets to repay dues will do so. Those who need to commit more equity will cough up the cash. Those who need to bring in outside investors, even at the risk of losing some control, will submit. Eventually this should slow the flow of bad loans, except in cases of genuine distress.
Finally, the clean-up and the resolution process, taken together, will help restore, what former RBI governor Raghuram Rajan, called the ‘sanctity of the debt contract’. “In India, too many large borrowers insist on their divine right to stay in control despite their unwillingness to put in new money,” Rajan had said in a speech in November 2014 before initiating the asset quality review. That perceived ‘divine right’ has now being taken away.
As a former central bank official put it: This will finally put the fear of God in the promoters, and prevent bankers from playing along.
(This article was first published on BloombergQuint.)
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