RBI Steps Into The Bad Loan Minefield
An amendment to the Banking Regulation Act, via the ordinance route, has landed the Reserve Bank of India (RBI) in the middle of the bad loan mess in the Indian banking sector. The amendments allow the RBI to direct banks on how to resolve a stressed asset. It can also ask lenders to initiate bankruptcy proceedings in a specific case.
The changes made to Section 35A of the Banking Regulation Act, which already gave the RBI fairly broad powers over banks, are intended to remove any ambiguity over whether the regulator has the power to intervene in commercial decisions.
The Ordinance reads: RBI may, from time to time, issue directions to banking companies for resolution of stressed assets.
It adds: The Central Government may by order authorise the RBI to issue direction to any banking company to initiate insolvency resolution process in respect of a default, under the provisions of the Insolvency and Bankruptcy Code, 2016.
Put simply, since bankers were unable (or unwilling) to take the tough decisions needed to resolve stressed loans, the RBI will now step in and do it for them. The regulator will have a say in how a bad loan account is restructured; how much of a haircut a bank needs to take and whether the management of a company needs to be changed. The top 50-60 loan accounts may be resolved through this process over the next six to nine months, said a person familiar with the plan.
The upside to this is that decisions may finally get taken. It could work in one of two ways. Either the threat of a case going to an RBI appointed committee could prompt errant borrowers and bankers to come up with a resolution plan. In cases where that threat doesn’t work, the RBI committee (it’s not clear what the composition of that committee will be) can step in and take a final call.
But there is a downside too.
As it gets directly involved in what should be purely commercial decisions, the RBI will get its hands dirty. And some of that dirt may stick.
Consider a purely hypothetical decision where the RBI directs a bank to sell a loan account at, say, 30 cents to the dollar. The bank executes the decision. Later it emerges that another party was willing to offer more. Or a change in industry conditions leaves investors believing that the bank took an unnecessary hit. Who will then be held accountable for the decision? Will it be the bank’s board? The RBI appointed committee? Or the RBI itself? If it is the regulator, then are they required to explain themselves? And to whom? A court? A parliamentary committee? An investigative agency? Or even an average Joe investor?
An equally valid question to raise is whether the RBI has sharper expertise in resolving bad loans than the banks themselves.
As a regulator, the RBI makes rules that it deems appropriate for the sector and enforces them. It understands the banking sector but does it understand the commercials of sectors like infrastructure, power or steel where most of the stressed assets are centered? The plan seems to be to get rating agencies to weigh in on the best course of action for individual accounts, said the person quoted above. Our rating agencies, however, have hardly inspired confidence over the past two years with sharp and delayed downgrades in cases like Amtek Auto Ltd. and Jindal Steel & Power Ltd.
At least two former RBI officials, who spoke to BloombergQuint on the condition of anonymity, expressed discomfort with the possible implications of a regulator, in this case also the central bank, getting embroiled in the messy process of bad loan resolution.
This proposal does enmesh the RBI in huge conflicts of interest, said one of them. On the face of it, this looks like a conflict of interest and micro-management, said the other. Both, however, acknowledged that they are not aware of the present circumstances to make a judgement on whether this was the only option left. It may have been.
Still, there may be collateral damage. Even Finance Minister Arun Jaitley seemed to accept that. Perhaps on the autonomy with which banks should operate. Also, on the arm’s length principle under which all regulators should operate.
“The object of this Act is that the present status quo cannot continue. And the present status quo is that not much was moving. Therefore, a paralysis in the name of autonomy is detrimental to the economy,” said Jaitley in a telling comment.
With this decision, the RBI also takes a step back from a long-stated goal of increasing the distance between itself and the entities that it regulates. Not too long back, till 2007, the RBI held a 60 percent stake in the State Bank of India (SBI). It transferred this to the government as the regulator’s ownership of a bank was seen as a clear conflict of interest.
Also, for many years now, the RBI has been trying to convince the government to let it withdraw its nominees on the boards of public sector banks.
In 2014, the PJ Nayak committee set up to review governance of bank boards, had laid out of a roadmap to strengthen these boards. Part of the plan was to let the RBI withdraw their board nominees.
The principle that RBI as the Regulator and Supervisor of banks should not be on bank boards (and therefore not be party to bank management decisions) is unexceptional. RBI has written to the Government seeking permission to withdraw its nominees (who could either be serving or retired RBI officers, as the Government ‘scheme’ requires them to have knowledge of ‘bank regulation or supervision’) from bank boards, except when there are special concerns.PJ Nayak Committee Report (May 2014)
Raghuram Rajan, former governor of the RBI, tried to do this during his tenure but did not succeed in convincing the government. He spoke of it during one of his last speeches before he exited the central bank.
Suggesting a series of steps to strengthen board governance, Rajan said that the ideal scenario would be for the RBI to perform a ‘purely regulatory role’ and distance itself from operational decisions.
RBI would perform a purely regulatory role, and withdraw its representatives on bank boards – this will require legislative change. Over time, RBI should also empower boards more, for instance offering broad guidelines on compensation to boards but not requiring every top compensation package be approved.Raghuram Rajan, Former Governor, RBI (August 2015 Speech)
The decision to get involved in bad loan resolution reverses this process, perhaps temporarily, and pushes the RBI closer to those it regulates rather the increasing the distance between the two.
One of the former officials referred to above summed it up well.
If this is a one time measure, it will leave a sour legacy, but may not do lasting damage. Longer run, the regulator simply cannot afford to be involved in making banking decisions.
Ira Dugal is Editor - Banking, Finance and Economy at BloombergQuint.