The Indian banking system, which is dominated by Public Sector Banks or PSBs, will need to get over with the problem of stressed assets soon, to attain a sustainable growth path in the coming future. Debt contract embedded in bank loans in India has been continuously losing its sanctity, especially where the borrowing is large.
Identification of Stressed assets
Rapid credit growth (in excess of 20% Y-O-Y) during 2006-2011, was the major reason for the growth in stressed assets. The high spurt in NPA during 2015 was due to RBI undertaking an Asset Quality Review (AQR), which qualified several standard assets as claimed by banks as Non-Performing Assets (NPA). Due to Asset Quality Review, NPAs went from 4.62% to 7.79% within a year, and it was 10.41% in December 2017.
Asset Quality Review
Central Repository of Information on Large Credits (CRILC)
- A central data warehouse was set up by RBI, as part of the framework for the resolution of stressed assets. This data warehouse CRILC(accessible by RBI and banks), captured all exposures of banks above Rs 50 million.
- It helps in giving a comprehensive view of the banking system and identifying exposure to a large borrower and how some exposures to the same borrower are classified differently by different banks.
- CRILC gave a complete picture on the movement of funds from one bank to other to keep an accounting standard.
- CRILC helps in identifying the likelihood of recovery of assets, as against what banks have classified.
Asset Quality Review with help of CRILC enabled RBI to get a banking system-wide view of large bank credits and identify their real health and recovery potential. This led to classifications of different assets into NPAs, which had not been recognized earlier by banks.
debt resolutions framework
Traditionally the normal principle for restructuring is that an account should be downgraded if any amount is forborne.
In August 2001, RBI put in place the Corporate Debt Restructuring (CDR) mechanism for restructuring of debt without the need for an asset quality downgrade if the restructuring plan met certain conditions. A major issue with this framework was that it became a tool for avoiding recognition of NPA, rather than resolution tool. (borrower-banker nexus)
During spurt in NPAs, the Reserve Bank allowed asset classification benefits for certain types of restructuring schemes.
- Strategic Debt Restructuring (SDR)
- Flexible Structuring of Project Loans
- Scheme for Sustainable Structuring of Stressed Assets (S4A)
The focal points of the schemes were:
- Deep restructuring of stressed assets
- Change of ownership/management of stressed borrowers
- Optimal structuring of credit facilities
- Haircuts wherever the exposures were economically unviable
Insolvency and Bankruptcy Code, 2016 (IBC)
In 2016, the Insolvency and Bankruptcy Code, 2016 (IBC) was enacted, which envisages timely resolution of borrower defaults through collective decision making by the creditors. IBC follows both process-oriented and time-oriented framework.
- Process-oriented: Detailing various steps that need to be followed once a borrower is admitted for insolvency
- Time-oriented: Specifies strict timelines for insolvency resolution, failing which the borrower would have to be taken into liquidation.
Internal Advisory Committee (IAC) – IAC was constituted by RBI in 2017, to determine cases referred under IBC. IAC identified a total of 41 accounts for such reference in two tranches. IAC recommendation was in consonance with Reserve Bank’s preference all along for an effective legal framework for insolvency and bankruptcy over regulatory mandated schemes.
RBI introduced a new framework for the resolution of stressed assets on Feb 12, 2018. This framework is more outcome-oriented and removes various process and input constraints which were there in the earlier version. It provides greater flexibility to banks to determine the process and contours of the restructuring plan to for time-bound resolution. If lenders and the stressed borrowers are unable to put in place a credible resolution plan within the timelines, then the structured insolvency resolution process under the IBC should take over. It reduces the arbitrage the borrowers are currently enjoying while raising funds through borrowing from banks vis-à-vis raising funds from the capital markets.
As a creditor, banks can renegotiate contracts, and bank books need to reflect this through asset classification and provisioning. The focus is on taking timely corrective action to avoid deterioration in asset quality. The credibility of the resolution plan, drawn by the lender, is sought to be ensured through the requirement of independent credit evaluation by credit rating agencies. To ensure greater credibility of the rating opinion, new framework prescribes “user pays” model for credit opinions – user here being the banks. Defaults are reported to a central database, which is accessible to all banks.
Note: It is mandatory to report defaults on a weekly basis, the classification of loans as non-performing assets will still be on the 90-day-past-due criterion.
Resolution plans can be implemented individually or jointly by lenders. Complete discretion and flexibility have been given to banks to formulate their own ground rules in dealing with borrowers who have exposures with multiple banks. Lenders can implement resolution plans that are tailored to their internal policies and risk appetites. At the end of the 180 days of first default, the borrower is in default to a bank, that bank is mandated to refer the case under IBC.
One of the features notices in the past was evergreening of loans to avoid the recognition of non-performance. The revised framework requires grant of additional credit facilities to a firm in financial difficulty to be treated as a case of restructuring and lists out the criteria for determining whether or not the borrower is in financial difficulty.
- For cash credit account, the 30-day trigger has been retained.
- The framework for restructuring has been consciously made non-applicable to the Micro, Small and Medium Enterprises (MSMEs) with borrowings of Rs 250 million and less.
Sign of improvement in the economy
- Sixth Bi-monthly Monetary Policy Statement, 2017-18 observed that there are early signs in the economy of a revival in investment activity as reflected in improving credit off take, large resource mobilization from the primary capital market, and improving capital goods production and imports.
- The process of recapitalization of PSBs has got underway, which has enhanced their ability to provide for credit losses as well as, in case of better-capitalized banks, to contribute to the credit growth.
- RBI has directed banks to file insolvency applications against largely distressed borrowers as mentioned earlier, and these accounts are getting resolved under the IBC.
- All these steps should improve credit flows further and create demand for fresh investment, which may further accelerate growth.
Most important questions which can come from Non-performing assets Resolution
Question 1: What is day limit for cash credit account?
Answer: 30 days
Question 2: What is the credit ceiling for MSME with regard to restructuring plan?
Answer: Rs. 250 million or Rs. 25 crore
Question 3: Who is the user is “user pays” model for credit opinions?
Question 4: Types of framework followed by Insolvency and Bankruptcy Code, 2016 (IBC) framework?
Answer: Time and process oriented
Question 5: What is CRILC?
Answer: Centralized database shared to RBI and all banks to monitor lender/borrowers and credit rating
Question 6: Name of a framework used by RBI for identification of stressed assets or NPA?
Answer: Assets Quality Review
Question 7: What is the major reason for the growth of NPA?
Answer: Access credit growth (20% annually) during 2006-11
Most Important terms used
Evergreening of loans, the user pays model, Internal Advisory Committee (IAC), Insolvency and Bankruptcy Code, 2016 (IBC), Central Repository of Information on Large Credits (CRILC), SDR, S4A, AQR
With this, we come to an end of this RBI speech on asset quality identification, and steps required for restructuring. Non-Performing Assets and Insolvency and Bankruptcy Code is one of the most important essay topics for UPSC, RBI Grade B, MBA admissions test.
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