The big bad, and sad, loan story

Here’s the proposed lifeline for banks with NPAs: if they run out of cash, they can convert SB accounts into FDs.

ByMeghnad S
The big bad, and sad, loan story
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The NPA saga continues! Bad loans keep piling up, banks keep pretending like everything is all right and a lot of experts on television keep talking about ‘haircuts’. Not actual hair. The financial kind. (I know, I find the term bizarre too.)

Three major developments have unfolded in the great Big Bad Loan story: Finance Minister announced a recapitalisation package (BAILOUT!), an Ordinance was cleared to make loan resolution easier and an intriguing bill was introduced in Parliament to save banks from utter collapse.

In the words of Dirk Gently of Dirk Gently’s Holistic Detective Agency, “Everything is connected”. So let’s get right into it!

But first, a quick recap

 The main character in our story is still this thing called “Non-Performing Assets” (NPAs). These are loans which haven’t been repaid and banks are now required to take action against the borrowers by selling off their company assets, taking over their companies and restructuring debt. All with the hope that some amount of the loan will be recovered.

It all started in December 2015 when Raghuram “putting sex back in the Sensex” Rajan told banks to clean up their books. Our banks were collectively being rather shady and hiding bad loans using some accounting tricks. They were not declaring non-recoverable loans as NPAs and weren’t starting the recovery process.

So Rajan was like, “Boss, too much shadiness only. Clean it all up.” (Read: Our Banks are in Trouble & We need to talk about it.)

Shit got real. Once the bad loans started tumbling out, banks practically stopped giving out more loans, putting an abrupt brake on Vikaas.

Meanwhile, to make loans more attractive, interest rates have been steadily reduced since 2015.

All thanks to the Monetary Policy Committee. (Read:  “Raghuram Rajan’s Successor Is A Committee”)

But, the NPAs remain with no sign of recovery. Something had to be done. And fast!

According to the Economic Survey 2017, 71 per cent of all loan defaults are by 50 companies which owe Rs 20,000 crore each to banks. The top 10 companies owe Rs 40,000 crore each (!!!).

The Bankruptcy Code was cleared by Parliament which makes it easier for business-folk and companies to throw up their hands and admit that they can’t fulfil their financial obligations. That was followed by Enforcement of Security Interest and Recovery of Debt Laws and Miscellaneous Provisions (Amendment) Bill, 2016. Or as I call it, “The Voldemort Bill.”

The Voldemort Bill gave special powers to these entities called Asset Reconstruction Companies (ARCs). Their job is to buy off bad debt from companies and try to recover as much as they can, in the most efficient way possible. They’re like specialists hired in crisis situations and they take the bad loans off bank books. The Voldemort Bill gave them superpowers and enabled them to do their thing faster. But, turns out, even that didn’t work as planned. Very few ARCs were interested to buy off these bad loans.

Alongside all this, the government also implemented the Indradhanush Scheme which poured Rs 70,000 crore taxpayer money into the murky pool of banks, over a period of 4 years, to recapitalise them. Given the incredible amount of bad loans, this amount is like a drop of perfume in the toxic ocean.

Enter Demonetisation

The entire country rushed to the banks to deposit all that cash. Our ex Attorney General went to the Supreme Court and declared that of the Rs 15 lakh crore demonetised cash, only Rs 10-11 lakh crore will come back. The rest would be surplus because it’s Black Money and can all be ‘extinguished’.

Even the Economic Survey 2017 pointed out that the unreturned cash can be used to save the banks.

Right around when the 50 days of Demonetisation ended, the government went ahead and passed an Ordinance to extinguish the unreturned cash. But this did not go as planned either because, disproving all Government estimates, 99 per cent of the demonetised cash was deposited back in banks. The thorough verification process by RBI of how much money actually came back still continues!

To put the whole story in a gist: Businesses took loans and couldn’t repay them (for both genuine and crooked reasons. Who knows these things), Government is trying really hard to make them pay back but failing. Meanwhile, because of all these bad loans, the banks are unable to give out new loans to enable Vikaas. In fact, credit growth dropped to a 60-year low (!!!) this year, all thanks to this batshit crazy mess. The only way banks will be comfortable giving out loans is if they are saved by the Government by pumping more money into them. All so that this pumped in money (read: Bailout) can become new fresh credit.

This brings us to the latest and greatest developments in our great Big Bad Loan saga. First up, recapitalisation.

Recapitalisation Bonds

Now that the unreturned-cash-extinguishing-dreams have been utterly extinguished, there is another way to route this extra, extra money in our banks to help solve the NPA situation. And all it needs is an accounting entry, of sorts.

Before we get into that, a bit about the morality of bailing out banks. There are two ways to look at this. One is that Public Sector Banks, which have the major chunk of NPAs at the moment, have gone on a misadventure, funded the wrong people and didn’t do the required homework before giving loans. Now that they have turned bad, the banks should suffer. We should all gradually move away from public sector banks and turn towards private banks which have proven to be more responsible.

The second argument is that a lot of public money is in these banks. They’re just giants which are now too big to fail. So big that if a large bank collapses, it’ll take the whole economy down with it. So, to prevent that situation, it’s only logical to keep funding it using taxpayer money and keep it afloat. Keep the show running and wait for the next crisis to hit, so to speak. Meanwhile, the loan recovery process can continue.

The Government, to give it some credit, was holding on and being strict with banks till this point of time. They refused to pump in taxpayer money into a never-ending crisis situation apart from the Rs 70,000 crore under the Indradhanush scheme. But it finally relented and announced a Rs 2.11 lakh crore recapitalisation scheme which will be executed over the next two years. Or a bailout. Call it what you will.

The recapitalisation/bailout has three components:
1) Government will buy Rs.18,000 crore worth shares of public sector banks. Taxpayer money.

2) Public sector banks will be asked to raise Rs. 58,000 crore from the market. Private money.

3) The government will issue “Bank Recapitalisation Bonds” of Rs 1,35,000 crore.  ¯\_(ツ)_/¯

Recapitalisation Bonds would work something like this: Government issues bonds which the banks will buy. That money will then be pumped back into the banks. Money goes from Bank to Government, then Government back to the Bank.

So the excess liquidity in the banks post-demonetisation (read, cash that everyone deposited) will be converted into a bailout package with a government guaranteed bond backing it. Basically, financial jugglery. Essentially, the government is using the money available with banks to recapitalise the banks.

At the moment, there is no option but to do this. Parallel efforts are on to recover the loans but that might take years. There is also the issue of preventing this whole misadventure from happening again in the future!

Which brings us to the next development: The sudden Ordinance.

The Insolvency and Bankruptcy Code (Amendment) Ordinance, 2017

This ordinance was issued on November 23, 2017. What’s weird is that this was done right after the Winter Session dates for Parliament were confirmed. Proving yet again that ordinances are extraordinary legislations which have basically become a shady way to subvert Parliament.

Oh well!

In June, RBI identified 12 companies which have defaulted and comprise 25 per cent of the total NPAs. Again in August they issued another list which identified 26 more high value defaulters. These companies are now facing debt resolution proceedings which need to be completed before mid-December. Their assets are being sold off, management is being changed and company operations are being taken over by different folks than the ones who caused the loan defaults. There’s a problem though.

Reports say that the old promoters of these companies are bidding on the assets of their own companies which have gone for debt resolution! Some are even using proxies and shell companies to buy back the assets of their defaulting companies. So to prevent that from worsening, this Ordinance was issued last week.

It simply says that 9 categories of people will not be able to participate in the resolution process of defaulting companies, which includes people who are insolvent, those whose accounts have been declared NPAs for more than an year, wilful defaulters and discharged directors.

The resolution scenario is now complicated because now it would take longer for the loan recovery since the promoters who were interested to put up money for defaulting company assets are out. And now there might be a situation where others might bid lower or be wary about bidding on these assets at all, thus only worsening out Big Bad Debt saga. The Government seems to have done the right thing by keeping out past defaulters from the whole process, but it will come at a cost which the taxpayer might have to bear. There is no way out of this.


Now… for the clincher.

So if the situation becomes worse, if the financials of banks take a sudden downturn taking the economy with it, we’re all screwed. Which brings us to the third development: The Contingency Plan.


Take a look at these three-four charts from the Economic Survey, 2017.

To put it mildly, the situation is bad.

Despite Government efforts, despite all the ninja financial moves they are doing, despite the resolution efforts by RBI, reports say that only 15-20 per cent of the total NPAs are in the mode for recovery. And they just keep piling up and bloating.

Public sector banks control about 70 per cent of the total share in banking sector. Given the shaky shady situation, deposits of people in these banks are at risk. If even a single bank collapses, the deposits in that bank vanish and might cause a cascading effect on other banks. So to protect the money of the depositors, a new law was introduced in Parliament during the Monsoon Session titled The Financial Resolution and Deposit Insurance Bill, 2017.

Earlier, every depositor was insured under The Deposit Insurance and Credit Guarantee Corporation Act, 1961 worth one lakh. That has been repealed and now it is up to the Resolution Corporation to decide how much insurance will be given to each depositor in case of bank failures. So there is no flat amount anymore and it might vary across banks and across depositor types.

On top of it, this bill introduces something called a “bail-in”. If you thought bail-out was bad, wait till you hear about this one. Here’s an excerpt from Section 52 of the proposed bill which defines a Bail-in:

What this means is that a bank which is in dire condition or facing losses will be allowed to ‘cancel’ deposits of people to maintain market credibility. The bank may also decide to modify the kind of deposits made into something else! Which means, it can just refuse to pay depositors who have savings account (with variable deposit insurance, as I pointed out before) or they may turn a savings account into a Fixed Deposit for say 10 years without the possibility of withdrawal.

To put it simply, when a person puts in money into the bank and demands it back, the bank has to obey. Because it’s not their money. But now, if the bank is suffering huge losses (say due to companies who took loans and wouldn’t pay back) it will simply refuse to give the money and instead issue shares or an FD certificate, all based on the decision taken by the Resolution Corporation.

Depositing money will no more be a saving which guarantees a depositor’s money is safe, now it’s an investment subject to market risks. (Please read the offer documents carefully before investing)

This contingency is being prepared in case of catastrophic financial events and extreme losses, like the kind that happened in 2008 in the USA. The bottom line seems to be that whether it’s a bail-in or a bail-out, the costs of the misadventures of banks and big corporations will be paid for by the depositor or the taxpayer, as the case may be.

Thankfully, this bill has been sent to a Parliamentary Committee and the report is expected to be tabled in the Winter Session. Hopefully the report will give us a proper rationale behind this bail-in provision.

Let’s just hope our banks remain strong, nothing goes wrong and otherwise we will all have to collectively ring the emergency gong.

Until next time, CONSTANT VIGILANCE!

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