RBI’s MSME Restructuring Guidelines A Dilution Of Asset Qualification Standards: Fitch Ratings

The Reserve Bank of India’s latest restructuring guidelines for micro, small and medium enterprises is a step back on asset classification standard imposed by the regulator, said Fitch Ratings India.

In a statement on Monday, the rating agency said that the latest restructuring announcement signifies a gradual shift away from the regulator's earlier effort to enhance the quality and transparency of asset classification in India’s banking system.

The RBI on Thursday said that MSME loans to companies registered under the goods and services tax will be eligible for a one-time restructuring process till Dec. 31, 2020. This is an extension of the restructuring guidelines which were announced in January 2019 and were supposed to end at the end of the ongoing financial year. The one-time restructuring will be applicable to loans which are stressed but are standard as of Jan. 1, 2020 and will not attract any asset quality downgrades.

“There is a risk that such regulatory forbearance will perpetuate moral hazard, as it follows aggressive lending growth and risk-taking in certain sectors in the five years to the financial year ended March 2019 (FY19),” Fitch Ratings said in its statement.

The RBI had decided to extend the due date for the restructuring scheme after Union Finance Minister Nirmala Sitharaman announced during the union budget this month that the government had asked the regulator to consider such an extension. When the guidelines were originally announced in January 2019, analysts had pointed out that this was a return to regulatory forbearance by the RBI.

The central bank had stayed away from forbearance since 2013 citing that such actions only delay the eventual impact of asset quality problems on banks’ books.

According to the rating agency, it is not clear at the moment whether this forbearance will be extended to non-bank financial companies as well, but Fitch Ratings said that the probability of this is high, considering the impact that the NBFC liquidity squeeze and a slowing economy have had on the MSME and real estate sectors.

“In recent years, banks have preferred to lend to NBFCs, which lend heavily to the real estate and MSME sectors, as a way to deploy their excess liquidity, while limiting their own direct exposure to these areas,” the statement said.

Indian banks have a poor track record with restructuring, Fitch Ratings said. The RBI’s asset-quality reviews in FY16 and FY18 found that a dominant share of loans restructured after FY12 had degraded into the non-performing category. In that context, Fitch said, it will make appropriate adjustments in order to objectively assess the performance of the underlying loan book of its rated entities in India to ensure their comparability with those of global peers.

The rating agency also pointed at the RBI’s announcements on improving credit flow to retail and MSME sectors, where the regulator allowed banks to not maintain cash reserve ratio for an amount equivalent to the incremental lending to these sectors between Jan. 31 and July 31.

“However, most of these sectors have had above-average lending growth in the last few years, either directly or indirectly via non-banks, and could be at risk were the economy to slow,” Fitch Ratings said.

The rating agency said that these measures are unlikely to support sustainable credit growth until capitalisation improves meaningfully across banks, in particular among state-owned banks, which account for nearly two-thirds of the sector’s assets.