NPA Resolution



SMERA Ratings finds positive impact of the new Act

The amendment of the Banking Regulation Act would give RBI more powers to directly intervene in NPA resolution; the development will help break the balance sheet sickness currently faced by commercial banks.


The RBI will have more powers to intervene in the resolution of NPAs, which are currently hovering near the Rs 9 trillion mark; overall stressed assets, including restructured accounts are estimated to be nearly Rs. 11-12 trillion. While the central bank was already supervising the banking system through the mandates set by the Asset Quality Review (AQR), the endorsement will allow the RBI to provide recommendations at the account level. The way RBI will operationalize these powers is through the constitution of sectoral/ oversight committees, which will in turn work with bankers and promoters for a quick resolution. Even though commercial banks will be involved in terms of decision regarding haircuts and asset reconstruction/ rehabilitation, the RBI will take over the onus from the regulatory point of view.  

Until recently, commercial banks were themselves responsible for deciding upon the fate of a bad loan. This exercise was often plagued by regulatory complications; also, multiple lenders to one account made matters complex. Initiatives such as Joint Lender Forums (JLF) were formed for precisely this reason but were bogged by a lack of consensus among lenders. Therefore for the resolution of every NPA account with multiple lender parties, the condition was met by an approval constituted by at least 60% by number and 75% by quantum. SMERA believes that the prevalent situation concerning the so called Twin Balance Sheet (TBS) problem was fueled by this dilemma as lending banks continued to sit on non-performing assets without any resolutions, over heating their balance sheets. The provisioning made for such accounts mounted additional pressure on bank Net Interest Margins and caused lending resources to diminish. In the scenario, without NPA resolutions, banks have become increasingly risk averse in their lending operations and credit off-take has declined below the five per cent mark.

We believe that this is also an appropriate time for the amendment due to the prevalent low interest rate regime. As per RBIs own estimations, every 100 bps increase in interest rate leads to a 0.6% increase in NPA (with one lag). Also, as global economy is estimated to strengthen this year onwards, overall economic activity will spur demand and hence capacity utilization levels - offering better chances to distress assets. Even though the Government has not initiated any plan to formalize an Asset Rehabilitation Agency, as proposed by the Economic Survey 2015-16, we believe that additionally, an entity that could take over stressed assets would have expedited the processes. This arrangement may be built around the concept of other successful examples such as the $431 billion United States’ Troubled Asset Relief Program (TARP), United Kingdom’s $60 billion UK Asset Resolution Company (UKAR) and Indonesia’s $60 billion Bank Restructuring Agency (IBRA). Such agencies function in a time bound fashion and are henceforth dissolved once the intentions are met. The arrangement can be more successful than the private Asset Reconstruction Companies (ARCs) since issued Security Receipts (SRs) could be fully backed by the Government, reassuring investors.    

With the direct involvement of the RBI, the Bankruptcy Code will also have more teeth due to faster referrals as the resolution will occur in a time bound fashion. While we await further details regarding the amendment, the move signals the Government and the RBIs intent to speedily de-clog the system through timely resolution of bad debt.