Restructuring of Loan Practices and its Implications for estimating NPA
Debt restructuring is the reorganization of borrower’s outstanding liabilities. It is generally a mechanism used by borrowers who are facing difficulties in repaying their debts. In the process of restructuring, the credit obligations are spread out over longer duration with smaller payments. This allows them flexibility to meet debt obligations. It is based on the principle that restructuring facilities available to borrowers in a timely and transparent manner goes a long way in ensuring their viability which is sometimes threatened by internal and external factors. This process tries to resolve the difficulties faced by the borrowers and enables them to become viable again.
NPA – A debt obligation where the borrower has not paid any previously agreed upon interest and principal repayments to the designated lender for an extended period of time. The nonperforming asset is therefore not yielding any income to the lender in the form of principal and interest payments.
The present system of estimating Non-performing assets (NPA) numbers as per the expert group’s suggestions is inappropriate. Yet, far from paying attention to the Group’s suggestion, the government is reportedly planning to do the opposite; which is to continue the existing practice of regulatory refraining from payment of debt. This would enable banks to restructure their short-term crop loans, particularly those made to small and marginal farmers, without classifying them ‘non-performing.’ Existing guidelines states, banks are required to set aside a certain amount of their profits as a cushion against the risk of default. Predictably, banks are required to set aside much more for sub-standard and doubtful assets compared to standard assets since there is a greater probability that such loans will not be recovered. So, by labeling sub-standard loans as standard, banks can get away with making much lower provisions and by extension, report higher-than-warranted profits.
Official sanction for such refraining might seem objectionable, but there is history. Banks have already been allowed to restructure loans and treat them as standard on fairly flimsy grounds. Since this allows them to reduce the amount they need to hold as provision against the risk of non-recovery, banks have been quick to seize the opportunity to restructure loans. According to the Expert Group, restructured standard loans stood at Rs. 1, 06,859 crore, higher than the gross NPAs of the banking system as at the end of March 2011. Since then, the pace of restructuring has shot up sharply as economic growth has slowed. Add to this the quantum of short-term credit to small and marginal farmers – approximately Rs. 2, 00,000 crore – to which the government now wants to extend regulatory refraining. And it is clear that a very substantial quantum of bank credit that should be as NPA will be treated now as ‘standard’.
The question is should we encourage such things
Or should we bring our system in line with international practices and mandate stricter rules while upgrading
so that the balance sheets of banks reflect their true financial position? Take, for instance, the international practice that restructured loans must be treated as inability if the restructuring is due to financial stress of the borrower. Or the requirement that satisfactory performance after restructuring is a must before the loan can be upgraded. Both these conditions have been vastly diluted in the Indian context. Consequently, a significant proportion of banks’ restructured standard assets are not ‘standard’ at all. However, thanks to regulatory refraining, banks can make lower provisions and report higher profits.
There is another reason to be worried when it comes to restructuring of loans that are in poor shape is that in other countries, restructuring is done only in exceptional circumstances and where the borrower is otherwise viable in the commercial judgment of the bank. In India, unfortunately, restructuring is often driven by irrelevant considerations: the political influence of the borrower (restructuring of Kingfisher Airlines’ loans) or political populism (small farm loans).
In such a scenario, we need to end the present system and force banks to make provisions in line with international best practices. If the government wants to come to the rescue of particular borrowers – whether corporate or farmers – let it do transparently, not by encouraging practices that result in bank balance sheets being dressed up to reflect a patently incorrect picture of their financial health. The problem is that, none of the parties – RBI, government, corporates and now, small farmers – has an incentive to change the situation. Banks, because they can show higher-than-warranted profits; the RBI, because it can present a rosier picture of the health of the financial sector; Government, because it reduces the pressure to recapitalize banks and wins it brownie points as well and Corporates and Small farmers, because restructuring gets them concessions they would not have got otherwise. So is it a win-win for all concerned? Unfortunately not so and the loser in all this is the luckless taxpayer. Prasad M L
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