The Economic Survey 2021 has called for a fresh review of asset quality of banks after the Covid-19-related regulatory forbearances are removed.
The regulatory forbearance must be removed as the economy improves and must quickly be followed up by a clean-up exercise of bank books, Chief Economic Adviser Krishnamurthy Subramanian said in the Economic Survey for 2020-21, released before the union budget presentation on Feb. 1.
“Given the problem of asymmetric information between the regulator and the banks, which gets accentuated during the forbearance regime, an AQR exercise must be conducted immediately after the forbearance is withdrawn,” the survey report said.
The survey report also suggested the following steps to avoid another banking crisis, after the Covid-related provisions are removed:
- New AQR must cover all creative ways in which banks evergreen loans.
- The RBI must be better equipped to find early fault lines and have an expanded tool kit in its remedial measures.
- The RBI may consider penalising bank auditors, if evergreening is discovered.
- AQR must be immediately followed up by a mandatory recapitalisation exercise.
- Need to strengthen bank boards to avoid evergreening of loans and zombie lending practices.
- Ex-post analysis of measures taken during a crisis must not equate bad judgement to malafide intent.
- Judicial infrastructure for the implementation of Insolvency & Bankruptcy Code — comprising debt recovery tribunals, National Company Law Tribunal, and appellate tribunals must be strengthened substantially.
Economic Survey 2021: Related Coverage
New AQR Unlikely To Find Any Holes
Bankers believe that the suggestion for a new AQR is not as troubling as it was in 2015. According to current and former bank officials, the last review made sure that the problems in banking system, whether it be quality of assets or lending practices, were more or less dealt with.
"Between the AQR of 2015 and now, a lot of recognition has happened. There is a lot of active supervision that happens in the banking system. Because of the reporting we do and the way banks are run, it may not be as bad a surprise as in the past," Ramaswamy Meyyappan, chief risk officer, IndusInd Bank told reporters over a conference call on Friday, after announcing the bank’s third quarter results.
Bankers say there have been multiple changes in the regulatory ecosystem and banking sector since 2015.
“Since the last AQR there has been a concerted effort from the regulator and banks to enforce greater control over troubled assets on balance sheets. The effects of that is visible in things like divergences reported by banks,” said Arijit Basu, former managing director, State Bank of India.
According to Basu, the information arbitrage between the lenders and borrowers and, by extension, the regulator, has come down in the last few years. Banks have been monitoring individual assets more closely and the insolvency law has also helped in better quality recognition of bad loans. However, Basu agrees that regulatory dispensations should be removed at the earliest.
Sunil Srivastava, former deputy MD at SBI noted that since the last AQR it is unlikely that banks would be resorting to much ever-greening.
“Lending to mid-sized corporates who do not have the ability to continue their business under the pandemic and also do not have adequate legal support to resolve the stress should not be mischaracterised as ever-greening,” Srivastava said.
Lessons From Forbearance Past
The Economic Survey identified issues with the previous regime of regulatory forbearance initiated after the global financial crisis and how it directly led to the banking crisis in later years.
Tthe regulatory forbearance introduced in 2008, according to the survey, was aimed at providing banks room to restructure stressed accounts amid a crisis and avoid high provisions. But even as the economy improved significantly, the forbearances remained, causing more complications for the banking sector.
The prolonged regulatory forbearance created a false sense of security for banks, which were not providing against restructured assets. Owing to this, banks consider capital held above the regulatory minimum as excess capital and continue paying dividends to equity holders, including the government.
“Thus, the usual pecking order of finance where debt is repaid before equity gets reversed. Eventually, when forbearance gets withdrawn, either depositors or taxpayers are called upon to foot the bill,” the survey said.
The forbearance also led to practices such as evergreening of stressed accounts and lending to zombie firms. Borrowers that took benefit of higher lending during the forbearance regime also indulged in misappropriation of resources, the survey said.
After the forbearance ended in 2015, the RBI proceeded to conduct an asset quality review of bank books to locate troubled assets that were not fully recognised as bad loans. “While gross NPAs increased from 4.3% in 2014-15 to 7.5% in 2015-16 and peaked at 11.2% in 2017-18, the AQR could not bring out all the hidden bad assets in the bank books and led to an under-estimation of the capital requirements,” the survey said.
The recent events at Yes Bank and Lakshmi Vilas Bank corroborate that the asset quality review did not capture evergreening carried out in ways other than formal restructuring. Had the review detected evergreening, the increase in reported NPAs should have been in the initial years of the exercise.Economic Survey 2020-21
Also, the asset quality review of 2015 was not connected to a mandatory recapitalisation effort, resulting in inadequately capitalised banks in the economy, and affecting direct lending. For firms, the reduction in the supply of bank credit reduced their ability to invest.
The survey report iterated the need for using these learnings in the fresh asset quality review it has recommended, so that the outcome can be better managed.
Economic Survey 2021: Related Coverage
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