Thou shall fix banks

There is some excitement that the Government of India has acted to address the issue of non-performing assets (bad loans) in the Indian banking system.

I think I have decent material (be warned of link fest) to blog on the Government Ordinance to amend the Banking Regulation Act to insert Sections 35 AA and Sections 35 AB of the Banking Regulation Act.

(1) Here is the PIB announcement:

The promulgation of Banking Regulation (Amendment) Ordinance, 2017 will lead to effective resolution of stressed assets, particularly in consortium or multiple banking arrangements

The Ordinance enables the Union Government to authorize the Reserve Bank of India (RBI) to direct banking companies to resolve specific stressed assets

The promulgation of the Banking Regulation (Amendment) Ordinance, 2017 inserting two new Sections (viz. 35AA and 35AB) after Section 35A of the Banking Regulation Act, 1949 enables the Union Government to authorize the Reserve Bank of India (RBI) to direct banking companies to resolve specific stressed assets by initiating insolvency resolution process, where required. The RBI has also been empowered to issue other directions for resolution, and appoint or approve for appointment, authorities or committees to advise banking companies for stressed asset resolution.

This action of the Union Government will have a direct impact on effective resolution of stressed assets, particularly in consortium or multiple banking arrangements, as the RBI will be empowered to intervene in specific cases of resolution of non-performing assets, to bring them to a definite conclusion.

The Government is committed to expeditious resolution of stressed assets in the banking system. The recent enactment of Insolvency and Bankruptcy Code (IBC), 2016 has opened up new possibilities for time bound resolution of stressed assets. The SARFAESI and Debt Recovery Acts have been amended to facilitate recoveries. A comprehensive approach is being adopted for effective implementation of various schemes for timely resolution of stressed assets. [Link – subject to change]

(2) Deep Advisory Services posts the exact Ordinance notification. There are three typos at least. Please catch them. I hope they were not in the original of the Ordinance itself and that these are errors made by the person who posted it. Otherwise, it is an embarrassment.

The Banking Regulation (Amendment) Ordinance, 2017

Extract of the Notification:

New Delhi, the 4th May, 2017

An Ordinance further to amend the Banking Regulation Act, 1949.

WHEREAS the stressed assets in the banking system have reached unacceptably high levels and urgent measures are required for their resolution;

AND WHEREAS the  Insolvency and Bankruptcy Code, 2016 has been enacted to consolidate and amend the laws relating to reorganisation and insolvency resolution of corporate persons, partnership firms and individuals in a time bound manner for maximisation of value of assets to promote entrepreneurship, availability of credit and balance the interest of all the stakeholders;

AND WHEREAS the provisions of Insolvency and Bankruptcy Code, 2016 can be effectively used for the resolution of stressed assets by empowering the banking regulator to issue directors [Oops!] in specific cases;

AND WHEREAS  Parliament is not in session and the President is satisfied that circumstances exist which render it necessary for him to take immediate action;

NOW, THEREFORE, in exercise of the powers conferred by clause (l) of article 123 of the Constitution , the President is pleased to promulgate the following Ordinance:-

(1) This Ordinance may be called the Banking Regulation (Amendment) Ordinance, 2017.

(2) It shall come into force at once.

In the Banking Regulation Act, 1949, after section 35A, the following sections shall be inserted, namely:-

‘35AA. The Central Government may by order authorise the Reserve Bank to issue directors [Oops!!] to any banking company or banking companies to initiate insolvency resolution process in respect of a default, under the provisions of the Insolvency and Bankruptcy Code, 2016.

Explanation. – For the purposes of this section, “default” has the same meaning assigned to it in clause (12) of section 3 of the Insolvency and Bankruptcy Code, 2016.

35AB. (1) Without prejudice to the provisions of section 35A, the Reserve Bank may, from time to time, issue directors [Oops!!!] to the banking companies for resolution of stressed assets.

(2) The Reserve Bank may specify one or more authorities or committees with such members as the Reserve Bank may appoint or approve for appointment to advise banking companies on resolution of stressed assets.’

PRANAB MUKHERJEE,

President. [Link]

It turns out that, indeed, the mistakes were made by the person who posted it. He could have ‘copied and pasted’ from the original. The original gazette notification of the full Ordinance can be found here and it is free of errors. This notification is filed under the Ministry of Law and Justice.

(3) Here is the notification in the Gazette of India. This notification is actually about the Finance Ministry invoking the powers granted the government by Section 35AA of the Banking Regulation Act as per the Ordinance to confer powers on the RBI to direct banking companies…… No typo here.

(4) MINT had this article on the three ways in which the proposed Ordinance was going to make a difference. Not very illuminating. Perhaps, there is more to it than what meets the eye in the innocuously worded Section 35 AB (2) above.

These committees may propose hair cuts? Binding on banks? Will investigative agencies refrain from reading mala fide intentions into such settlements?

(5) On the last question above, this MINT article has a useful pointer:

“There was a proposed amendment to Prevention of Corruption Act introduced in Parliament. Standing committee has already considered it and submitted its report,” said Jaitley.

There you go.  That might be the key.

(6) The article cited in (5) above also raises some other questions:

“So now the government can direct RBI to have a bank sit down and resolve a specific stressed asset. But what next?” asked Anurag Das, managing partner of Rain Tree Capital, a Singapore-based investment manager specializing in distressed and special situations. “The key to a fair price is attracting enough participants. So how do we get real participants to assess and bid in the IBC timeline?”

A regulator deciding in which case insolvency should be filed poses many challenges, said Sumant Batra, insolvency expert and managing partner of law firm Kesar Dass B. & Associates.

“A lender or borrower are in best position to decide whether to commence insolvency or not. RBI will need to appoint experts to scrutinize each case as it cannot be an administrative decision. The best way to encourage banks to resolve stressed assets under the bankruptcy code is to offer them some incentives to file (for) insolvency,” said Batra.

I suppose Mr. Batra’s comment on experts is taken care of by Section 35 AB (2). The question is whether banks agree on the price and proceed to write down the asset, take a hit on profits and the Government of India (GoI) will receive lower dividends and/or inject capital or close down or merge the banks.

All of these remain unaddressed by the Ordinance. May be, the government has a roadmap for all these crucial questions. Or, not.

(7) These comments in a FE article do not help me understand in what way the RBI was disempowered in the past and in what specific way, it is now empowered to deal with the problem:

Though the RBI had powers under the Section 35 A of the Banking Resolution Act 1949, to issue guidelines for the banking companies, but they had not been specific. Section 35 AA and Section 35 AB introduced today in the Act, allows the government to authorise RBI to take specific measures to solve issues.

The situation now is that 50 big cases can be taken up together in a time-bound manner in a particular time frame. Committees which will be set up by the RBI will also help banks to know exactly what to do to resolve the NPA issues. [Link]

May be, the difference lies in ‘guidelines’ vs. ‘directions’ that RBI can now issue to banks. But, was the RBI not empowered earlier to form ‘oversight’ committees to help banks solve the issues of pricing, hair cuts, takeover, restructuring and reorganisation of assets? Were there explicit provisions in law that forbade either the commercial banks or the RBI from doing so, before?

Not rhetorical but inquisitive questions.

(8) This story in the Financial Express merely repeats the RBI notification on the Joint Lenders’ Forum. The useful thing though is that it clarifies that RBI had reduced the threshold for the JLF to move on the matter of NPA resolution. It was 75%. Now, it is lower. Find the RBI notification here.

To facilitate timely decision making, it has been decided that, henceforth, the decisions agreed upon by a minimum of 60 percent (75% before) of creditors by value and 50 percent (60% before) of creditors by number in the JLF would be considered as the basis for deciding the CAP, and will be binding on all lenders, subject to the exit (by substitution) option available in the Framework.

(9) This ‘Edited Excerpts’ of the interview of ET NOW with Abizer Diwanji of Ernst & Young India is not very helpful because there is a disconnect from his answer to Q1 and the second question.

For example, he says:

There is a reasonable justice that comes through from the vigilance providers to make sure that people are not unnecessarily penalised. To take away the moral hazard and put into the RBI’s basket, I do not think is going to help.

But to actually enable banks to take bold decisions will certainly help. So one has to see what the legislation comes up with. If there is only an amendment in 35A, I think that would not go down very well. But if there are amendments to coming to the bankruptcy code, policies which say that there are legitimate consequences that can come about and get PSU banks to move towards the bankruptcy code, I think that legislation would help.

That was my initial reaction. I thought the Ordinance passed the buck to RBI and I was not sure that RBI did not have powers earlier to do some of the things that it is now being specifically empowered to do. I had made this point earlier. May be, the devil is in the details, as I had indicated above (‘guideline’ vs. ‘direction’).

(10) As a layman (not a lawyer, that is), I find Section 35 A of the Banking Regulation Act 1949 sweeping enough:

35A. Power of the Reserve Bank to give directions

(1) Where the Reserve Bank is satisfied that-

(a) in the [public interest]; or
[(aa) in the interest of banking policy; or]

(b) to prevent the affairs of any banking company being conducted in a manner detrimental to the interests of the depositors or in a manner prejudicial to the interests of the banking company; or

(c) to secure the proper management of any banking company generally, it is necessary to issue directions to banking companies generally or to any banking company in particular, it may, from time to time, issue such directions as it deems fit, and the banking companies or the banking company, as the case may be, shall be bound to comply with such directions.

 (2) The Reserve Bank may, on representation made to it or on its own motion, modify or cancel any direction issued under sub-section (1), and in so modifying or cancelling any direction may impose such conditions as it thinks fit, subject to which the modification or cancellation shall have effect. [Link]

The Section 35A and some provisions in it have been inserted in 1956, 1960 and 1968 respectively.  They seem broad enough for RBI to act. IF it has not acted on these, I doubt if it was lack of legal empowerment. May be, it was waiting for the political signal.

In other words, the utility of the Ordinance lies in the political signalling rather than incremental empowerment of RBI, the Banking Regulator.

If so, cliched as it might be, the proof of the pudding of political will to tackle the issue will come in the eating, when certain assets of certain borrowers are auctioned off, equity rights stripped, management changed and bankruptcy initiated – if they happen, that is.

(11) Well, may be, that is a trifle too cynical or narrow or both. As this article in Business Standard points out, the Ordinance is part of the new ‘NPA Framework’. Of course, there is no document that is available for us to examine the elements of this new ‘NPA Framework’. This article provides us glimpses.

Specifically, it says,

There is also an associated implication of the ordinance in the manner that the provisions of the Bankruptcy Code have now been linked to the Banking Regulation Act. Prior to the Union government directing the RBI to initiate the NPA resolution process, the government now has to establish the incidence of a default as defined under the Code. So far, the linkage between the Bankruptcy Code and the Banking Regulation Act was not there and could have come in the way of the central bank taking action against any bank for ignoring a default. [Link]

The statement is speculative in nature. My reading of Section 35 A of the Banking Regulation Act tells me that it is comprehensive enough already and RBI (or, for that matter, any one) could have invoked any law of the land, including the new Bankruptcy Legislation 2016 to expedite matters. So, it might be a case of hesitancy on the part of the regulator not knowing the extent of political will. Perhaps, again, this Ordinance and the new NPA framework is a case of mustering political will.

(12) I doubt if the ‘NPA framework’ or the Ordinance addresses the issues raised below in the ‘Business Standard’ article. May be, not all information is in the public domain yet and they may be released in installments. The Ordinance is the first installment of actions, may be.

The operation of the Bankruptcy Code helped the situation only up to a point. The policy as well as regulatory environment was such that asset reconstruction companies (ARCs) were unable to strike deals on buying sticky loans on which they hoped to make reasonable returns. On the other hand, the bank managements were not bold enough to sell the sticky assets to ARCs at such discounts as would make the deal remunerative.

This called for regulatory reforms that, on the one hand, would have allowed ARCs to be floated by private equity firms that could take the risks and, on the other, would have allowed banks to take the financial hit on such loans in return for a more healthy-looking balance sheet. Since such reforms did not take place, let alone being on the cards, nothing much changed as far as ARCs’ capability of making a dent on stressed banking assets were concerned. [Link]

(13) This article provides more details on the NPA framework:

The new framework to deal with Rs 6 lakh crore worth of toxic assets was approved by the Cabinet on Wednesday. It contains a set of fresh guidelines for public auction of assets by public sector banks (PSBs) for the steel and power sectors, which account for a majority of toxic assets.

Sources told Business Standard that when stressed assets were put on the block, banks would reach out to state-owned companies to buy those up. “Large cash-rich public sector companies will be encouraged to buy the assets being auctioned in their sector by the state-owned banks,” an official said.

Clearly, this is meant to address the political fallout of auctioned assets being sold off cheaply to private interests. To what extent is the sales to public sector companies a good thing, economically, is debatable. In fact, if this process results in a higher public sector share of India’s economic output generation, I wonder if it is really a good thing.

(14) ‘Business Standard’ proceeds to give us more glimpses of the contents of the NPA Framework document.

Besides, the board for financial regulation and supervision will be tightened further.

“The NCLT will be strengthened with additional manpower now that we expect many companies whose balance sheets have turned toxic and are beyond revival to undergo proceedings,” the official said.

The framework also envisages amendments to the Prevention of Corruption Act to exempt commercial decisions by PSBs from scrutiny by investigating agencies. Both the amendments are likely in the monsoon session of Parliament.

The government has asked banks to provide data on their top NPA accounts. It has also sought more information from consortium leaders. [Link]

What are the two amendments referred to above? I can see only one.

(15) There is a useful image in the Business Standard article on the NPA numbers.

(16) This article was dated two hours earlier than this article also both of them provide the same information. The second article, I think, merely updates the information on the Presidential assent.

(17) There is also a short interview with Sanjeev Sanyal, Principal Economic Advisor to Government of India who reiterates that Delhi would not interfere with Mumbai (read GoI/PMO/MoF with RBI).

Conclusion:

What comes through is that there seems to be an incremental political will to let the process of NPA resolution move on. The government has sought to insulate itself from pulls and pressures from delinquent bank borrowers by empowering the RBI to take necessary actions by issuing directions to banks. The RBI had promptly revised the terms of the Joint Lenders’ Forum.

But, as stated more than once in this post, the Government’s resoluteness on resolving the issue will be tested when specific situations emerge.

The situation on attracting bidders for auctioned assets remains unclear. Pricing has to be right. That would open up a different set of issues. I had mentioned them above. They do not seem to have been clarified yet.

However, the Government seems to be ducking the issue or solving the issue cleverly by letting Public Sector Entities bid for the assets. They may be under pressure to bid for the assets at higher prices. In other words, this is a backdoor re-capitalisation of banks by the government through public sector entities. May be, this is the core of the NPA framework and the rest is a nice obfuscation. That is a cynical but not wholly unreasonable view of the package.

The Cabinet has approved a ‘NPA Framework’, which only ‘Business Standard’ seems to have seen.

The issue of amending the ‘Prevention of Corruption Act’ has been flagged much earlier. The government is acting now, it seems. See my article in ‘Swarajya’ published a year ago. It still remains relevant and a useful benchmark to compare this new ‘NPA Framework’ (whatever we have seen of it through ‘Business Standard’ articles).

Clearly, the opportunity to use the crisis to re-organise or restructure Public Sector Banking itself seems to have been passed up. Or, may be not. But, seeing the ‘escape clause’ of auctioning assets off to public sector undertakings, it is possible to guess that the government would not be keen on diluting or abandoning or radically recasting the Public Sector nature of Banking in India. A wasted opportunity.

Perhaps, a strict-to-fair grading for the package is 1.5 cheers and a fair-to-liberal grade for the package is 2.0 cheers.

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