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New bad loan rules: Darkest hour before dawn

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Near midnight on Monday when the country was asleep the Reserve Bank woke up Indian borrowers to a new world of disciplined repayment, and the Indian banker to a stricter regime of bad loan classification and resolution. The question bankers and borrowers are now asking; is the RBI trying to achieve Utopia in a day?

The new bad loan resolution rules are by far the best in class. In the first place they do away with the myriad resolution plans such as Corporate Debt Restructuring (CDR), Strategic Debt Restructuring (SDR) and Stressed Asset Structuring (S4A). This step was inevitable. All those restructuring gimmicks were needed in an India where there was no Bankruptcy Code. Now with the code in place and the bankruptcy courts (or NCLTs) up and running, these schemes needed to go.

The new rules also require banks to report defaults over Rs 5 crore on a weekly basis to the RBI’s centralized database called CRILC.  All banks, thus know who are the stressed borrowers almost instantly and thus, have enough time and information on the borrower to regularize his repayment ability.

The new rules also ensure a sunset to the ongoing restructuring schemes under CDR, SDR and S4A. At least some were invoked to get a standstill on their getting classified as NPA. Many of the restructurings aren’t working out. For loans over Rs 2,000 crore RBI has given six months from February 12, to get implemented fully. Else they go to the bankruptcy courts. In future as well, loans of over Rs 2,000 crore get 6 months from date of first default to be resolved. Else they go to the bankruptcy courts.

Most impressive is the way in which RBI has calibrated the flow of cases to the bankruptcy courts. First 12 marquee cases sent in June 2017, then 28 cases sent six months later, and now, nine months later all the cases over Rs 2,000 crore have been referred. By then the tribunals, the resolution professionals, and committee of creditors may be more seasoned to resolve cases faster.

The new rules also ensure restructurings are no eyewash.  For loans over Rs 100 crore a rating agency shall rate the restructured loan as investment grade. For loans over Rs 500 crore, the revamped loan will require investment rating from two rating agencies.

All told, the new rules are exactly how the rules should have been from the start. Timely payment of interest by borrowers, or the system punishes you; and appropriate classification and provisioning by banks, so the mess doesn’t accumulate.

That said, let us tiptoe to reality.  Most bankers believe the new rules will lead to a spurt in loan defaults in the next few quarters. Here’s why:

Firstly, a resolution plan has to be okayed by all banks. Bankers worry the approval from 75 percent or even 51 percent of the lenders has been a problem. This requirement of approval from all bankers for a resolution to become applicable will mean more failures and more cases going to the bankruptcy courts.

Secondly, getting an investment grade from the rating agencies for a resolution plan can be an uphill task. So far, these agencies have waited for the loan to perform for a year before raising their rating. Getting two rating agencies to give the required grade will be tougher. In an atmosphere where all institutions – banks, audit companies, boards,  - are facing distrust, many a resolution may fall short of the required grade and again end with the bankruptcy courts. And all these loans are being forced to the bankruptcy courts when the process, while showing promise, has yet to yield results.

Thirdly, the process to upgrade a restructured loan to standard status is more demanding. It will require the borrower to repay 20 percent of his principal before being upgraded. This means for a longer period, income from the loan can’t be recognized, and the NPA will show up in the ratios and the risk capital.

Fourthly, the loans currently under SDR or CDR or S4A have to be resolved in six months. Else more cases will end in the bankruptcy courts requiring immediate accelerated provisioning.

Net net, the widespread fear is that an immediate increase in slippages is likely, at least, from cases under the various old CDR and SDR schemes.  This will hit provisioning, and may be absorb most of the capital that came from the recap bonds leaving little for growth. The more demanding process of upgrading loans will keep incomes subdued for banks.

The bigger problem will be if IndAS is implemented starting April. IndAS requires that for every new loan, provisions have to be kept depending on the bank’s loss-given-default of the past three years. The new rules hit when the NPAs are at their highest and hence, every new loan can become too expensive. There is a good chance therefore, that credit growth may slacken for the next few quarters.

No doubt once these few quarters are lived through, the banking system will emerge vastly stronger and cleaner. But for the banks, the midnight jolt from RBI will mean nightmares first, and sunrise after a rather long night.