Of recapitalisation and resolution of NPAs | Business Line

Even as bail-in won’t work in the Indian banking system, extra vigilance is called for to track the path of lending decisions

The Reserve Bank of India’s governor, Urjit Patel, interacting with the press on December 6, mentioned the Centre’s recapitalisation plan. He emphasised that the plan envisaged not only recapitalisation but reforms too; the reforms would be differentiated amongst public sector banks (PSBs).

PSBs that have managed their balance sheet well will have front-loading of recapitalisation bonds. The other banks will receive government support based on their resolve to undertake reforms in a time-bound manner. These reforms will be measured in terms of capacity of banks to become “slim and trim” and follow better focused business strategies, including sale of non-core assets. The Government is also considering governance reforms for all PSBs.

The governor mentioned that this reform package aims to ensure that money is properly utilised to strengthen the balance sheet of PSBs. Accordingly, the Monetary Policy Statement of December 6, mentions that with the recapitalisation plan of PSBs, foreign portfolio inputs into equities resumed sharply in October 2017 after recording outflows in September. Thus, it can be implied that global financial markets carefully watch the domestic markets in India.

Encouraging sign

The distinction being made between well-performing and non-performing PSBs is appropriate strategy. There are two related issues. In recent days, the bail-in clause in the Financial Resolution and Deposit Insurance (FRDI) Bill 2017 is also being discussed. Though internationally accepted, mainly in G-20 countries, it may not be appropriate for the banking system in India. In emerging countries, banks play an important role in financial intermediation. In view of under-developed financial markets, banks are the main source of finance for industry and commerce, especially small and medium enterprises. In advanced countries, stock markets and other funds play an important role. To garner resources for lending, deposits are important for banks. A bail-in clause can scare depositors and redirect their savings into gold, land, chit funds and even cash. In the present stage of growth of the financial system in India, the bail-in clause will encourage shadow banks and defeat the purpose of demonetisation where substantial amounts of cash were deposited in the banking system.

The other issue that needs careful consideration is the resolution of NPAs and treatment accorded to entrepreneurs in industry. There could be different reasons for rising NPAs. Consequently the diagnostics have to be carefully analysed on a case-by-case basis. It is necessary to determine whether NPAs are emerging because of malafide intentions or due to general economic slow-down, because the treatment would differ accordingly.

Need to be vigilant

The problem of NPAs does not emerge instantly; it generally has a time-line over which the situation deteriorates. As in an ICU where doctors know the health of the patient before the family does, similarly, bankers become aware of NPAs in the industry they have financed. Therefore, it is also the responsibility of the board of directors of banks, to be vigilant while taking lending decisions. Similarly, chartered accountants, auditors and legal experts associated with the industry where NPAs are rising should also be held responsible by investigating agencies.

In the resolution of rising NPAs, the Kingfisher case can be considered a litmus test. Three important implications associated with KC being tried in the UK court need consideration. First, it can encourage the domestic industry to explore possibilities of tax havens mainly for survival during rainy days. Second, and obviously, this will encourage the generation of unaccounted money in the economy. Finally, and most importantly, many related but irrelevant issues regarding the business environment in India would be argued in an international public space such as treatment accorded to economic offenders, slower dispensation of justice, and condition of prisons. These could damage India’s reputation as an attractive destination for investments. This could also reverse the ranking in “ease of doing business” which factors in variables like enforcing contracts and resolving insolvency.

In a dynamic, emerging economy like India with a young population seeking employment, banking sector issues arising out of excessive risk-taking can be expected. As in the case of fiscal issues where finance commissions are set up regularly and a permanent fiscal body for setting GST rates has been established, the Government could consider a permanent banking commission to address concerns. Further, as was the practice in the 1990s, there is a need to periodically consider well-represented banking committees to provide a strategic road map for reforms.

The writer is RBI Chair professor of economics at IIM Bangalore

(This article was published on December 13, 2017)

via Of recapitalisation and resolution of NPAs | Business Line

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