What are the urgent next steps in banking sector reforms?

  Apr 03, 2017

What are the urgent next steps in banking sector reforms?

Banking Sector requires action on three fronts: NPAs
The traditional strategy for dealing with NPAs has been to reschedule the loans. However, this helps only where projects suffer from a short-term “liquidity problem”. It cannot help when there is a “solvency problem”, i.e. the income stream simply cannot service the debt even over a longer period. Most of the large NPAs reflect solvency problems. revenue streams were overestimated and costs have increased beyond original projections. Such projects can only be rescued if banks take a haircut and reduce the debt. Understandably, this is something bankers hate to do.

How to go about it?
There are two ways of handling the problem. The Reserve Bank of India (RBI) has notified schemes for both, but neither of them has worked.
  1. The Strategic Debt Restructuring Scheme allows banks to convert the debt into equity, take control of the project, remove the existing management, and induct new management. Ideally the project should be auctioned off to the highest bidder and the existing management, if not suspected of malpractices, should also be allowed to bid. The difference between the amount paid for the equity and the value of the debt converted, is a market-determined debt write-off. The scheme has not worked for a variety of reasons. These include problems of coordination among the different banks involved, regulatory uncertainties (especially for infrastructure projects) which deter new investors, and the unwillingness of bankers to accept a sufficient write-down of the outstanding debt. There is also the practical problem of running the projects taken over until a new management comes in. Banks are ill-equipped to do this.
  1. The second option is to work with the existing management and negotiate a suitable debt reduction. This is what the RBI’s most recent Scheme for Sustainable Structuring of Stressed Assets (S4A) was designed to do. It has the advantage of not having to look for a new management, but since the incumbent management remains in place, and the debt write-off is not competitively determined, there is a danger that the concessions given may attract the charge of cronyism and corruption.
Some think that the problem can be overcome by setting up an independent “oversight body” to approve the debt reduction terms. But since the oversight body will also consist of public servants, the problem remains. PoCA clearly needs to be amended, and a proposal pending in Parliament should be expedited. However, this may not suffice, because proposals for a settlement have to be developed by bank managements, and then submitted to the oversight mechanism. Bankers have no incentive to propose large reductions in debt, especially since it is an implicit acknowledgement of poor lending practices on their part.

Bad Bank Recapitalization of public sector banks Reforms in the banking sector
Looking ahead, we cannot avoid serious banking sector reforms if we want the public sector banking system to become more efficient. This is bound to take a toll on our economic prospects for the next several years until private sector banks grow in size and come to dominate the market. But that could take 20 years.