The recent clarification by the Reserve Bank of India on non-performing advances (NPA) may increase non-banking financial companies’ (NBFC) bad loans by one-third, says a report.
Last month, the RBI had provided clarification on income recognition asset classification and provisioning (IRAC) norms for banks, NBFCs and All-India Financial Institutions.
The clarification included classification of special mention account (SMA) and NPA on a day-end position basis and upgrade from an NPA to standard category only after clearance of all outstanding overdues.
“The RBI’s clarification on non-performing advances (NPAs) accounting is likely to increase NPAs by around one-third for non-banking finance companies (NBFCs),” domestic rating agency India Ratings and Research said in a report on Friday.
However, the impact on provisioning could be modest, given NBFCs are using Indian Accounting Standards (IND-AS) and generally for higher rated NBFCs, provision policy is more conservative than IRAC requirements.
The report said the RBI circular also calls for daily stamping of accounts to count the number of days they are overdues instead of a monthly or quarterly stamping.
This again would result in an accelerated pace of NPA recognition for accounts, it said.
NBFC borrowers, typically where there is cash collection, pay their overdues generally with some delays. Accounts can get into NPA category just for a day’s delay in paying the instalments and once it gets categorised as NPA it will not be able to become standard unless all the arrears are cleared, the report said.
“So, in other words, accounts would get categorised as NPAs at a faster pace and would remain sticky in that category for a longer period of time. Both these accounting treatments would result in higher headline numbers for NBFCs,” it said.
It may so happen that NBFCs would disclose NPA numbers as per IRAC norms and stage 3 numbers as per Ind-As separately in their disclosures, the agency said.
Bad bank refers to a financial institution that takes over bad assets of lenders and undertakes resolution.
“The Indian Banks’ Association (IBA), vide their letter dated May 13, 2021 requested Canara Bank to participate in NARCL as sponsor. The board of Canara Bank has given in-principle approval for taking stake in NARCL,” Canara Bank said in a regulatory filing.
Following the board nod, it said, the bank has sought the approval from the Reserve Bank of India for participating in NARCL as sponsor contributing 12 per cent stake.
Various public sector banks (PSBs) have also announced that they have earmarked a signification portion of their NPAs to be transferred to NARCL.
For example, Punjab National Bank (PNB) said that it has identified non-performing assets of Rs 8,000 crore to be transferred to NARCL.
The proposed NARCL would be 51 per cent promoted by PSBs and remaining by private sector lender.
Banks have identified around 22 bad loans worth Rs 89,000 crore to be transferred to the NARCL in the initial phase.
Finance Minister Nirmala Sitharaman in Budget 2021-22 announced that the high level of provisioning by public sector banks of their stressed assets calls for measures to clean up the bank books.
“An Asset Reconstruction Company Limited and Asset Management Company would be set up to consolidate and take over the existing stressed debt,” she had said in the Budget speech. It will then manage and dispose of the assets to alternate investment funds and other potential investors for eventual value realisation, she added.
Last year, the IBA had made a proposal for creation of a bad bank for swift resolution of non-performing assets (NPAs). The government accepted the proposal and decided to go for asset reconstruction company (ARC) and asset management company (AMC) model for this.
The IBA was appointed nodal agency to constitute the Asset Reconstruction and Asset Management Companies designated as NARCL and India Debt Management Company Ltd (IDMCL) respectively.
The lockdown restrictions were relatively higher in South and some parts of central region,” said Rajat Kumar Singh-business head of MicroBanking and Rural Banking, Ujjivan Small Finance Bank.
Banks saw a significant drop in collection efficiencies for micro-loans during April and May as income generation of borrowers were badly impacted and movements of staff for collection activities in the field were restricted due to lockdowns across multiple states amid the second Covid wave.
Lenders feel that collection efficiency is likely to be ‘volatile’ in the first quarter of the current fiscal year due to the intermittent lockdowns, and the number of micro-finance customers availing loan restructuring will depend on how the economic scenario pans out post-lockdowns. They may be in a position to know the actual number of accounts required to be restructured by July.
As small entrepreneurs and individuals have continued to be affected under the second Covid wave, RBI has announced the Resolution Framework 2.0. for a one-time restructuring scheme. Banks and lending institutions can invoke restructuring under this framework till September 30.
“One EMI restricted collection efficiency in the inclusive finance business as on March 31, 2021, was 85%, which improved from 81% in December 31, 2020. In the month of April 2021 it was 83%. Collection efficiency is likely to be volatile in Q1FY22 due to the intermittent lockdowns. The second wave of Covid has been very severe in phases for the entire country,” Baskar Babu, MD and CEO, Suryoday Small Finance Bank, told FE.
“Due to the uncertainty created by the second wave, we will have to wait for a quarter to understand the incidental impact on collection efficiency. However, things are gradually improving and our focus continues to be supportive to our customers, as they navigate these tough times,” Babu said.
For Ujjivan Small Finance Bank, at the end of March 2021, 96% of its micro-finance customers were paying, fully or partly. In April, collection efficiency dropped to 88%. And, collection efficiency was lower in May compared to April. “In the month of May, majority of states were under lockdown with different levels of restrictions. The lockdown restrictions were relatively higher in South and some parts of central region,” said Rajat Kumar Singh-business head of MicroBanking and Rural Banking, Ujjivan Small Finance Bank.
According to him, the impact on collection efficiency this time around is not as severe as compared to the first wave. “We will provide the option of restructuring to all stressed customers. Additionally, we will also disburse loans to eligible customers to provide them the required liquidity support for revival of their income. This way, customers will be provided assistance to resume their business activities and get back to normalcy,” Singh added.
According to big data analytics company Spocto Solutions, which helps banks with its digital platform on collection-related activities, overall collection efficiency came down significantly not only in micro-finance segment, but also in segments like affordable housing, auto and personal loans. “Bankers work with us for segmentation of borrowers and offering them differentiated solutions. There is a segment which needs restructuring, while there is a segment which may need deferment of payments for a month or two. If there is a real problem, lenders are using us to help borrowers restructure their loans,” Sumeet Srivastava, founder and CEO, Spocto, told FE.
ESAF Small Finance Bank said going ahead the outlook seemed to remain ‘bleak’ for some more time, and how fast the sector will recover depends on the customer segments. However, it expected things to pick up by July 2021. “Customers availing restructuring depends on how the economic scenario will pan out, post lockdown. Generally, the MFI sector picks up faster than any other segment,” the bank added.
The earlier FSR released in January 2021 had projected that the gross non-performing assets (GNPAs) of banks may rise to 13.5% by September 2021 in the baseline scenario.
By Nitin Jain
In Feb 2021, RBI announced a structure for a proposed bad bank, “What you call a bad bank is not really that; an ARC-type entity will be set up to take over bad loans from the books of public sector banks and it will try to resolve just like any other ARC,” RBI Governor Shatikanta Das had said.
Proposed Structure of Bad Bank
Though no formal structure has been announced yet, we understand basis news reports, that a National Asset Reconstruction Company Limited (NARCL) is going to be set up to take over NPAs from banks. The Promoters are likely to be power finance companies while the PSU banks will hold the remaining equity stake in the ARC. As per recent news reports, state-owned banks have shortlisted 28 loan accounts to be transferred to the NARCL with a total of Rs 82,500 crore of loans due, and further loans could also be transferred such that the AUM is over Rs 2 lakh crore. The list of borrowers includes big names such as Videocon Oil Ventures Limited (VOVL), Amtek Auto, Reliance Naval, Jaypee Infratech, Castex Technologies, GTL, Visa Steel, Wind World, Lavasa Corporation, Ruchi Worldwide, Consolidated Construction.
Normally the NPA loans at the time of takeover by an ARC are valued around 30-40% of the principal amount. However, as we understand from news sources, in the case of NARCL the loans may be acquired at the current book value. The NARCL would pay 15% in cash and the balance 85% in security receipts or any other proportion as they may decide. Further, the government would provide a guarantee to the security receipts issued by the bad bank. Let’s assume that a bank sells a loan of Rs 100 to NARCL. Now, if the Bank has already made 75% provisions for the loan, then the book value of this loan is Rs 25, and 15% of Rs 25 i.e. Rs 3.75 is cash to be paid to banks. Thus, using these assumptions, for taking over say Rs 2 lakh crore of bad loans, a cash outflow of Rs 7,500 crores and issuance of SRs worth Rs 42,500 crore may be required. (Please note that these assumptions have been taken for the purpose of explaining this concept only and are not indicative or confirmatory in any nature).
Pros and Cons of the Proposed Bad Bank Structure
Pros -Cleans the balance sheet of the banks. -Will provide immediate relief to the banking system which will now be facing fresh NPA on account of disruption due to Covid. -Banks will become capitalized and ready for fresh lending. -Faster decision making by one body (NARCL) v/s Consortium of banks. -A secondary market can be created for the SRs which have a sovereign backing, that would provide further liquidity to the banks.
Con The actual recovery of these loans may be lower than the book value of the loans transferred, thereby could lead to erosion of capital at NARCL over the medium and long term. -If NARCL will need to take decisive, focused steps to recover these loans, otherwise the process may not be successful. -The process entails transferring the bad loans at current date, and recovery or resolution to happen in future. -May lead to aggressive fresh lending by Banks.
Taking control of management of these companies from the Promoters. The RBI had demonstrated effective management of DHFL, by taking over the board and appointing an administrator to manage the company and find a resolution.However, a Bad Bank, or even a network of bad banks, will not make the losses disappear. The losses, or non-performing loans, transferred to a bad bank will still exist. The process may allow better recovery of these loans in future. It will be important for the banks to review their lending policies and put in place a robust risk management system. Further, it would be crucial to see how NARCL will manage these bad assets. I believe that one will require specialized expertise for recovery of these bad assets such as:
-Interim Crisis Management in these Companies – restructuring, reducing costs, identifying surplus assets and to sell these assets to generate liquidity, and providing transparent and clear communications to all stakeholders. -Classification of bad loans by sector. The Government already has significant expertise in the Road/ Highways and Power Sector via its Undertakings. However, expertise may need to be built in other sectors via sector experts to facilitate day-to-day management of the operations of the company and to find a viable resolution to preserve value. -Provisioning policies of NARCL will need to be reviewed such that they are in accordance with the tenor/ maturity of the SRs issued. -NARCL will need to take a decision as to the route to be taken for recovery from the bad loan. Some potential routes could be:
Initiating corporate insolvency process on the Company
Engaging an investment banker to pursue mergers and acquisitions transaction for the said asset.
Undertake a compromise or settlement u/s 230 of Companies Act.
Though the ‘Bad Bank’ appears to be a sweet pill for the banking sector to get rid of their immediate problems, it would be a tough task ahead for the proposed NARCL to preserve the tax- payers’ monies over the medium and longer term.
(Nitin Jain is a veteran corporate and investment banker having worked in banks like Standard Chartered Bank and Bank of America. He is a Restructuring Expert and is also an Insolvency Professional registered with IBBI. The views expressed in the above article are the author’s personal views.)
An examination of the transition of a constant sample of non-PSU non-financial wholesale performing exposures to SMA status between August and November 2020 reveals accumulation of outstanding in SMA-0/1/2 categories, although the aggregate outstanding has remained flat, the RBI said.
The ratio of accounts in the special mention account (SMA)-2 category of the private sector non-financial wholesale segment rose to 7.2% as on November 30, 2020, from 1.7% on September 30, 2020, the Reserve Bank of India (RBI) said in the December 2020 edition of its financial stability report (FSR).
The sharp rise in SMA-2 loans coincided with the Supreme Court’s stay on recognition of bad assets after August 31.
SMA-2 loans are those where repayments have been overdue between 61 and 90 days and their ratio as a share of advances signifies the level of incipient stress in the system. Once an account remains irregular for 90 days, it is classified as a non performing asset (NPA) or a bad loan.
An examination of the transition of a constant sample of non-PSU non-financial wholesale performing exposures to SMA status between August and November 2020 reveals accumulation of outstanding in SMA-0/1/2 categories, although the aggregate outstanding has remained flat, the RBI said.
A similar accumulation of exposure is seen when gross outstanding at every SMA cohort is compared between August and November 2020. “Admittedly, the asset classification standstill inhibits the true underlying economic categorisation of assets, although the incipient tilt is towards worsening as indicated by the growth in balances in the next worse categories for each cohort,” the report said.
Interestingly, corporate asset quality had been on the mend through the first half of FY21. The share of large borrowers in the aggregate loan portfolios and gross NPAs of banks declined to 50.5% and 73.5% respectively in the quarter ending September 2020. At the same time, the share of restructured standard advances increased, indicating that large borrowers have started availing restructuring benefits extended for borrowers facing Covid-related stress.
The proportion of substandard and doubtful advances contracted while that of loss assets increased, reflecting ageing of the NPA portfolio. As of September 2020, the top 100 large borrowers accounted for 17% and 33.7% of banks’ gross advances and large borrower loans, respectively. “Although this represented a decline vis-à-vis March 2020, the share continued to remain above pre-Covid levels, indicating persisting credit concentration,” the report said.
While the overall lending rates have declined when we look at the headline rates, the transmission is probably slower when we look at various products or risk segments.
India’s banking sector saw its gross non-performing assets (GNPA) come down in the second quarter of this fiscal year. The GNPA ratio of SCBs improved to 7.7% in the quarter ended September against 9.3% in the year-ago period, CARE Ratings said in a report. Although the asset quality of the banks seems to be better, the improvement has come owing to the moratorium offered by the Reserve Bank of India (RBI), recoveries and higher write-offs made by multiple banks. “As per disclosures by banks, the Gross NPAs would have been around 0.5% to 0.6% higher had these (moratorium) accounts been classified as NPAs,” the report said.
Asset quality improves
Among state-owned banks, India’s largest lender State Bank of India (SBI) reported the highest asset quality improvement, with a decline in GNPA ratio to 5.3% in the second quarter of this fiscal year against 7.2% a year ago. SBI accounts for nearly 20% of public sector bank GNPAs. Punjab National Bank (PNB) reported GNPAs at 13.4% against 16.8% a year ago. “Net NPAs also shrank to Rs 2.1 lakh crores in Q2FY21 from Rs 4.5 lakh crores in Q2FY19 reflecting an increase in provision coverage ratio (PCR),” CARE Ratings said.
Recoveries were better in the fiscal second quarter, helping in improving the asset quality of banks. SBI’s recoveries stood at Rs 4,038 crore, ICICI Bank was at Rs 1,945 crore, followed by Bank of Baroda with Rs 1,642 crore worth of recoveries. “On an overall basis PSBs accounting for 75% share of GNPAs of SCBs have experienced a drop in the GNPA ratio to 9.3% in the quarter ended September against 11.6% in the year-ago period,” the report highlighted.
Skeletons to be unearthed ahead?
CARE Ratings said that now that the moratorium offered by the banks has been lifted, the after-effect and the impact on the banks’ balance sheets may be witnessed in the latter part of the year and subsequent period. Banks have been ordered to not declare covid-19 related defaults as NPAs until further notice, hence keeping the GNPA ratio lower. However, following this many banks have kept aside extra provisioning for NPAs that may arise in future, making higher provisions in September.
The report said that in the coming quarters provisions of SCBs are likely to remain elevated on account of the recognition of stressed assets owing to Covid-19 and its disruptions affecting the businesses which could impact the financial performance.
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