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Thank you for inviting me here
today. In a country that is growing at above 7 percent, is brimming with
entrepreneurial zeal, has a young population which has grown up with mobile
technology, one would think that the banking sector would be buoyant. Yet the
recent decline in bank share prices has investors on the edge. Of course,
part of the reason is that markets are in turmoil. Some of the greater
decline of bank share prices can therefore be explained by the fact that
they are seen as a leveraged play on the economy. On bad days, they move
down more, on good days they move up more. With markets generally in
decline, the decline in bank share prices has been more accentuated.
However, part of the reason is
that some bank results, mainly public sector banks, have not been, to put
it mildly, pretty. Clearly, an important factor has been the Asset Quality
Review (AQR) conducted by the Reserve Bank and its aftermath. So it may be
useful to understand the rationale for the AQR, the process, and what I
believe will be the outcome.
Dealing with Stressed Loans
Over time, as you know, a number
of large projects in the economy have run into difficulty. Reasons, as Mr. Mundra articulated this morning, include poor project
evaluation, extensive project delays, poor monitoring and cost overruns,
and the effects of global overcapacity on prices and imports. Loans to
these projects have become stressed.
There are two polar approaches
to loan stress. One is to apply band aids to keep the loan current, and
hope that time and growth will set the project back on track. Sometimes
this works. But most of the time, the low growth that precipitated the
stress persists. The fresh lending intended to keep the original loan
current grows. Facing large and potentially unpayable debt, the promoter
loses interest, does little to fix existing problems, and the project goes
into further losses.
An alternative approach is to
try to put the stressed project back on track rather than simply applying
band aids. This may require deep surgery. Existing loans may have to be
written down somewhat because of the changed circumstances since they were
sanctioned. If loans are written down, the promoter brings in more equity,
and other stakeholders like the tariff authorities or the local government
chip in, the project may have a strong chance of revival, and the promoter
will be incentivized to try his utmost to put it back on track.
But to do deep surgery such as
restructuring or writing down loans, the bank has to recognize it has a
problem – classify the asset as a Non Performing Asset (NPA). Think
therefore of the NPA classification as an anesthetic that allows the bank
to perform extensive necessary surgery to set the project back on its feet.
If the bank wants to pretend that everything is all right with the loan, it
can only apply band aids – for any more drastic action would require NPA
classification.
Loan classification is merely
good accounting – it reflects what the true value of the loan might be. It
is accompanied by provisioning, which ensures the bank sets aside a buffer
to absorb likely losses. If the losses do not materialize, the bank can
write back provisioning to profits. If the losses do materialize, the bank
does not have to suddenly declare a big loss, it can set the losses against
the prudential provisions it has made. Thus the bank balance sheet then
represents a true and fair picture of the bank’s health, as a bank balance
sheet is meant to. Of course, we can postpone the day of reckoning with
regulatory forbearance. But unless conditions in the industry improve
suddenly and dramatically, the bank balance sheets present a distorted
picture of health, and the eventual hole becomes bigger.
In 2008-9, after the global
financial crisis, the Reserve Bank agreed to forbear on certain kinds of
stressed loan restructuring, hoping that this was a temporary need pending
stronger growth. Unfortunately, for a variety of reasons, the stress has
not been temporary, and growth in these sectors has proved elusive.
Therefore, early in the process, the Reserve Bank set about giving banks
the tools to deal with stressed loans, including information about the
degree of the borrower’s collective indebtedness from the system and more
effective ways to reduce the project’s financial stress such as the Joint
Lender’s Forum, the Strategic Debt Restructuring mechanism, and the 5/25
mechanism. In a way, the RBI has been trying to create a functioning
resolution process in a situation where the existing bankruptcy system
functions poorly.
Asset Quality Review
Of course, every new tool can be
used to deal with a problem, but also perversely, to avoid it. So after
giving banks the tools, the RBI ended forbearance in April 2015, and then
started the Asset Quality Review to ensure that banks were taking proactive
steps to clean up their balance sheets. Working with the banks, our
supervisors, led superbly by our head of banking supervision, Ms. Parvathy
Vairasundaram, our Executive Director for supervision, Ms. Meena
Hemchandra, and, of course, our Deputy Governor, Shri S.S. Mundra,
identified loans that were of concern, as well as loans that had potential
weaknesses. For the loans that are of concern, the banks are attempting to
regularize the loans that can be put back on track, and are classifying
those that cannot for deeper surgery – and taking provisions in accordance
with the degree of extant stress in the loan. They will also make
provisions for loans that have weaknesses. Our intent is to have clean and
fully provisioned bank balance sheets by March 2017.
Why not do everything in one go
rather than over a period of six quarters? Precisely because a number of
these loans can be regularized, or stabilized when weak but regular,
through the right collective actions. Sometimes, an NPA classification,
even while permitting deeper surgery, prompts risk aversion on the part of
bank boards and they stop lending even when the project is viable. We need to
overcome this view – we have issued circulars stating that a loan to a
project whose other loans are NPA does not automatically become an NPA –
but it will take time. Pending the change in attitude, which I think will
come as banks turn to unlocking the value in NPAs, we are working with them
to sequence the most obvious actions up front. However, the end game is
clear to everyone and bounded. We do not envisage a sequence of AQRs.
Having pointed out the contours
of the task to be accomplished, our teams are working with the banks to
ensure that they are all broadly on the same page in terms of recognition
and provisioning, even though each one has flexibility on individual cases.
This means that December 2015 quarter results can be compared across banks to
get a rough sense of the task each bank has to accomplish. Some banks have
expressed an intent to moves faster, so as to put the problem behind them,
and we have not held them back. We have not put out any of our final
estimates because we believe it is a moving target, with more bank action,
promoter response, and growth diminishing the eventual cost. It is
important to recall that underlying many of these stressed loans is an
economically viable productive asset, not ghost townships.
A lot of work has gone into this
review, including many meetings with the Government at every level
including the highest. The Government has been fully involved and
supportive. We have mapped out a variety of scenarios on possible outcomes.
The Finance Minister has indicated he will support the public sector banks
with capital infusions as needed. Our estimate is that the Government
support that has been indicated will suffice. Our various scenarios also
show private sector banks will not want for regulatory capital as a result
of this exercise. Finally, the RBI is also working on identifying currently
non-recognizable capital that is already on bank balance sheets, such as
undervalued assets. The RBI could allow some of these to count as capital
as per Basel norms, provided a bank meets minimum common equity standards.
There are some wild claims being
made by some financial analysts about the size of the stressed asset
problem. This verges on scare-mongering. Our projections are that any
breach of minimum core capital requirements by a small minority of public
sector banks, in the absence of any recapitalization, will be small. They
will need government equity or preference share infusion since they are
typically banks that will find it difficult to raise equity in the markets.
A few others will need a top up of their capital to ensure they have a
reasonable buffer over and above minimum capital. What the Government has
already explicitly committed is, in our view, enough to take care of all
reasonable scenarios, and the Government has committed to stand behind its
banks to whatever extent needed. The RBI will provide whatever liquidity is
needed by any bank that needs it, though we do not foresee liquidity
stress.
In sum, while the profitability
of some banks may be impaired in the short run, the system, once cleaned,
will be able to support economic growth in a sustainable and profitable
way. The economic assets of our public sector banks, such as the trust they
are held in by the population, their knowledgeable employees, their
location and reach, and the low-cost funding they have access to, can then
be fully realized.
Why Now?
Why now? Why did we have to pick
this period of global market turmoil for banks to start cleaning up? Why
not let growth take care of the problem? As I have already said, the
process started in April 2015. We knew at that time that the global economy
would continue to be weak but not that markets would be in turmoil today.
Nevertheless, this simply reinforces our belief that we needed to act when
we did.
While growth will help the
system, it would likely be significantly impaired if we did not nudge the
process of clean up. Non-food credit growth from public sector banks, the
more stressed part of the system, grew at only 6.6% over the calendar year
2015. Industrial credit growth for PSBs was only 3.3% while growth in
lending to agriculture and allied lending was only 10.4%. The only area of
strength was personal loans, where growth was 16.9 %. In contrast, non-food
credit growth in private sector banks was 20.2 %, in agriculture 25.4%, in
industry 14.6%, and 23.5% in personal loans. Put differently, in each of
these areas except personal loans, loan growth in private sector banks was
at least 10 percentage points higher than public sector banks, while loan
growth in personal loans was 6.6 percentage points higher.
The most plausible explanation I
have is that the stressed balance sheet of public sector banks is occupying
management attention and holding them back, and the only way for them to
supply the economy’s need for credit, which is essential for higher
economic growth, is to clean up. The silver lining message in the slower
credit growth is that banks have not been lending indiscriminately in an
attempt to reduce the size of stressed assets in an expanded overall
balance sheet, and this bodes well for future slippages. In sum, to the
question of what comes first, clean up or growth, I think the answer is
unambiguously “Clean up!” Indeed, this is the lesson from every other
country that has faced financial stress.
Some citizens are outraged by
the size of the losses that will have to eventually be absorbed and want
the perpetrators to be brought to justice. Let me emphasize that all NPAs
are not because of malfeasance. Indeed, most are not. Loans can go bad even
if the promoter has the best intent and banks do the fullest due diligence
before sanctioning. Nevertheless, where there is evidence of malfeasance by
the promoter, it is extremely important that the full force of the law is
brought against him, even while banks make every effort to put the project,
and the workers who depend on it, back on track. This is why we have
strengthened the fraud detection and monitoring mechanism, and look forward
to bank support to make it effective.
The Government is taking direct
action to clear bottlenecks and revive stalled stressed projects, and
intends to support them with equity infusion through the National
Investment and Infrastructure Fund. Private well-funded players are looking
to buy assets, and in recent weeks we have seen some promoters sell assets to
raise money to pay banks or infuse in projects. All this activity bodes
well for the success of the clean up.
Improving Bank Management and
Governance
We must also ensure that we are
not faced with this situation again. The Government, through the
Indradhanush initiative, has sent a clear signal that it wants to make sure
that public sector banks, once healthy, stay healthy. Strengthening Board
and management appointments, decentralizing more decisions to the
professional board, finding ways to incentivize management, all these will
help improve loan evaluation, monitoring and repayment. Banks must review
their procedures to ensure they can make good credit decisions. The new
bankruptcy code, when enacted, will finally give creditors a way of
collecting repayment through the judicial process in reasonable time. So my
hope and belief is that the next time will be different for public sector
banks – they will emerge from this clean up stronger and more capable.
Liquidity
Let me turn to a final issue,
unrelated to the AQR, that is, system wide liquidity. The RBI has been
infusing plenty of liquidity in the system to offset any seasonal build up
in Government balances. Indeed, money market rates have dipped dramatically
on some days because of the liquidity infusion. Nevertheless, market
participants have complained about shortage.
We invited a number of market
participants to the Reserve Bank to discuss their concerns. While we are
still trying to understand which of their concerns have merit and can be
addressed, we are acting today on one issue that we were cognizant of, the
use of SLR bonds to meet Liquidity Coverage Ratio needs. While the circular
was in the works, we have expedited its issue because of what we heard from
the participants. As of today, we will allow banks to count 3 percentage
points more of their SLR holdings towards LCR requirements. A more detailed
announcement will be released this evening.
In Conclusion
The market turmoil will pass.
The clean-up will get done, and Indian banks will be restored to health.
While we should not underplay the dimensions of the task, we should be
confident that it is manageable and that the Government and the RBI will do
what it takes to make sure that banks are able to support the tremendous
growth that lies ahead. Thank you.
https://www.rbi.org.in/Scripts/BS_SpeechesView.aspx?Id=992
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