What is the background on this issue and why it is so significant that RBI is coming up with the revised guidelines on resolution of bad loans?
The background concept is arising out of inability to pay the debt. Whenever ever a constituent borrower falls into the definition of non performing asset which as per the earlier prudential norms (which now stands abolished of course), the concept of bad loans arises. Now the new circular which has been released on 12-02-2018 regarding revised guidelines is basically to cover a situation where you do not wait for something to become extinct and non performing. That is the concept of bad loan where by either the collateral or the security is vanished or the interest compounding is much more than the principal or the inability to pay the debt by the constituent borrower happens to be a biggest accident in the banking industry.
When will a loan become a bad loan? Assume that somebody has taken a loan if he doesn’t pay will the loan become a bad loan? Or can he be given some time?
Under the existing framework earlier prior to this there was a period of 90 days whereby if payment of an instalment or on the interest attributable to the instalment was not received by a bank, the bank could continue necessary 90 days and treat it as irregular. After the expiry of 90 days, it would fall into the definition of an Non Performing Asset and then classified as bad loan or irrecoverable debt. Now that concept has been abolished on 12.02.2018. Now what RBI says is that instead of approaching for the 90th day if somebody defaults even a single payment then from day one to day thirty (the following 30 days), the action for recovery can be taken. That means if somebody defaults into the timetable of schedule of the repayment say for instance one person takes a loan of Rs. 100 which is payable in instalments of Rs.10 each on expiry of 30 days. Suppose he defaults on 3rd instalment, then the bank can proceed with the recovery procedure immediately after the due date, according to the Banking Insolvency Code (BIC). This means instead of looking at 90 days, we are looking at one day.
How bad is the problem of bad loans ? We have been hearing different things from different people. Some people say that Rs.lakhs of crores have been stuck in bad loans. Any estimates about the magnitude of the problem ?
With Demonetisation, all the currency coming into banking system, the Banking industry was reaching a level of buoyancy. So what happens to all these funds received by the banks? The banks park the funds in certain kinds of debts. When those debts are not recoverable, it will result in a big loss to the exchequer. Probably it could be lakhs and crores of rupees locked up in bad loans. We have the results coming out from various Public Sector Scheduled Banks with regard to the extent of this problem. On 13.02.2018 there had been a heated debate in the Parliament regarding at what level the action should be taken. The magnanimity of the problem lies in the fact that the Banking industry is supposed to lock up all of its funds into that and when everything goes into NPA, it is basically occurring because of the accumulation of inaction by the Banking industry. In 2016, the Insolvency and bankruptcy code (IBC) was enacted by the Parliament which was basically to address the issue that the borrowers or rather the defaulting borrowers were taking undue advantage of the laxity in recovery procedures. There was a concept of 90ndays during which no action could be taken. This 90 day period was becoming something like a holiday period for the borrowers to arrange their affairs in such a manner that they would escape the recovery proceedings by the Public Sector Banks (PSBs).
Debt Recovery Tribunals (DRTs) are there and lot of efforts were made by the Government and the RBI and also the banks to recover the bad loans. What prompted the RBI to come out with a revised guidelines and how different are they from the previous guidelines?
The previous guidelines were very friendly to the borrowers. It was very lucrative for the borrower to borrow money and take advantage of the delay in recovery proceedings. The machinery, the system, the industry all put together was not equipped with a quick judicial remedy. Even the debt recovery Tribunal is a judicial process. Under the Civil Procedure Code, the cross examination, play of timely evidence, submission of evidence was taking number of years. In fact a person running an ancillary unit winds up his business and declares himself insolvent and goes to the DRT, the proceedings would last over a decade to get concluded. On the contrary, there has to be a hasten up process whereby we do not wait for the 90th day. With this kind of a thing, the Reserve Bank of India has acted in all its dynamism. In fact before the issue of this circular on 12.02.2018, there was consequential empanelling, there were kinds proper amendments in the RBI Act and the Banking Regulations Act whereby enabling provisions were there and the power of the RBI was enhanced to issue such guidelines. Now here what the guidelines basically mean is that i. they address the look at the concept of a bad debt in a different perspective ii. They look at the symptomatic analysis of factors which go to build up a bad debt iii. Immediate recovery proceedings on a timely action based on the principle that a stitch in time saves nine. For instance in the earlier system, one had to wait for 90 days. Instead now one can immediately take timely action and before the symptomatic analysis reflects something different. The way the new circular has analysed of looking at the bad debt problem, we can say that the whole perception has undergone very big metamorphosis and a very big change for the better.
In layman terms: What does it mean and how will it help in resolution of bad debts?
- First part of the circular is dedicated to the creation of a special mention accounts i.e., an account which is developing certain kind of symptoms. Like how doctor looks at the symptoms of the patient and do diagnosis, before the systems develop into a disease, the same approach has been followed in the circular. What earlier was happening in the Banking industry was that each such thing was not nipped in the bud. With this new approach, the new circular in the beginning itself it classifies SMAs of categories. SMA stands for Special Mention Accounts. It casts an obligation on the banks to make a special mention of category wise of certain SMA0, SMA1, SMA2 on the basis of classification that anything will become overdue between day one to day thirty. If there is any defaulter in this period, that should reflect in the bank’s SMA statement. For instance if a unit was financed with Rs.5000 and that it was supposed to pay first instalment of Rs.500 but defaulted. So the banks will identify this as it is going in the wrong direction and then flag it. Necessary steps would follow. Therefore again we have 31-60 days and 61-90 days. So it is like a focus is being made on the symptoms of banking industry. Banks don’t need to wait till the last stage where NPAs will become a reality. Therefore the SMA analysis /Special Mention Account analysis is a very healthy way of looking at the defaulting constituent borrowers. After this the circular takes us to a resolution plan. Once we have diagnosed something we then need to have a resolution plan. Resolution Plan basically refers to identifying something, recognising the evil and taking necessary steps which could be financial, non financial, legal or maybe structural. Remember one more thing, here the circular is saying that resolution plan has to be done in a timely manner. The circular applies to all the banks. If a particular Bank does not fall into the pattern of the resolution plan or does not take timely action, there is adequate provision made for penalising the banks. After all bank is described as a trader for money. A bank buys credit and sells credit. Bank buys money and sells money. Now when it is buying money, it pays interest. If bank sells money or sells credit, it recovers interest. If a bank is taking good money from the masses and giving it to bad money such a banker is not to be tolerated under the new RBI revised guidelines. Then we come to the best part of the circular which is the appendix describing symptomatic analysis where the financial difficulty is defined. If there is a project delay, then that is a symptom of becoming a bad debt. Whether it is controllable or not controllable, whether it needs restructuring whether it is at the managerial level, or at the administrative level, are all the cause-effect relationships. What the Reserve Bank of India wants is Rich Banquet to do in a timely manner is if it doesn’t want to be penalized, or visited with heavy measures in terms of the circular then they have to address the whole issue when it is at the stage of financial difficulty. In fact by the time the circular becomes operative (most of the clauses would be coming into effect from 1st of March 2018, some have alredy come into force) all the existing circulars etc habe been withdraw and will cease to operate as of now. When you look at the examples of the symptomatic analysis whereby unit has failed to pay the statutory liabilities. That itself should be an indication for the Bank management to wake up and recognize the symptom where the working capital analysis is going haywire or there is a default in the margin house keeping. The borrower is not able to maintain the drawing power allotted to him in a cash credit account not just once but on a continuous basis. Such habitual irregularities are taken as symptoms of financial difficulty which has to be addressed by the banker in a timely manner.
Isn’t there too much onus on the banks themselves? In fact they are the custodians of public money, so whenever they give correct it is their duty to ensure that the principal and the interest is paid back. But will it not make the lives difficult for banks as well as for the industry also because a time may come when they may face genuine difficulty and there could be some delay in the repayment of instalments?
Reserve Bank is considered as a central bank which can be likened to a school master while all the other commercial banks may be likened to children in class. Show the school master has to be harsh if he wants disciplined economy based on disciplined set of procedures in the banking sector. What is happening is even if the law is on your side, even then because of the lethargy or inaction or inertia having in the track record, if the banks follow the old norms, then there would be big track record of high incidence of NPAs. The NPAs have arisen not because of political reason but because of violation of prudential norms due to 90 days clause. Now the RBI is converting the banking industry with the help of Banking Insolvency Code. They say we want to take action against you as an insolvent. That action even can be taken even in the next day. So the banks wait for a default and in the next morning can proceed with legal proceedings. In the judicial side, Debt Recovery Tribunals are available but delayed justice is no justice at all. By the time judgment is even passed in favour of the bank, the security is gone or it loses its value and the debt and the interest factors far over cross the Reserve price itself. So therefore defacto loser is always the lender bank. As a custodian of public property, as custodian of public funds, banks cannot be compromised on disciplined recovery proceedings.