Coming clean on NPAs

BL:26 July 2012

It is in banks’ interest to recognise the diminution in the ‘fair value’ of impaired assets, ‘regulatory forbearance’ or not.

A Reserve Bank of India (RBI)-appointed panel has rightly recommended that all bank loans being subject to ‘restructuring’ be classified as non-performing assets (NPA). Currently, such loans are treated as ‘standard’, even when the terms of their restructuring involve banks taking a hit, whether through reduction in interest rates, elongation of repayment period, part waiver of principal or interest, and so on. Whichever way one sees it, restructuring entails borrowers being granted concessions that the banks would not otherwise even consider

. Moreover, not treating these loans for what they are — in practical terms, their performance is nothing but ‘sub-standard’ — makes no sense when the amounts involved are not small either. Between March 2009 and March 2011, the gross NPAs of Indian banks rose from around Rs 68,000 crore to Rs 94,000 crore. 

But restructured advances, technically regarded as ‘standard’, soared even more from just over Rs 60,000 crore to almost Rs 107,000 crore. While there are no figures yet for 2011-12, an indication can be had by the Rs 206,500 crore worth of loans referred only to the banking industry’s formal corporate debt restructuring cell as on end-March.

There is little to be gained from making fine distinctions between NPAs and ‘restructured loans’ that merely obfuscate the underlying problem of bad debts. The panel under the RBI Executive Director, Mr B. Mahapatra, has correctly observed that restructuring of a bank account amounts to an “event of impairment”, whether or not its asset classification undergoes a downgrade. Since international accounting standards and regulations followed in advanced economies treat any restructured bank account as impaired, there is no reason for India not aligning its prudential guidelines with the global best practices. 

This is required especially from a transparency angle: A bank may show only, say 3 per cent its gross advances to be NPAs, when it might also be having equal or more loan amounts earning a fraction of the cash flows projected prior to restructuring. In doing so, the bank would be misleading both depositors and investors, as they fail to get a picture of its true financial position, warts and all.

Of course, reclassifying all restructured loans as impaired overnight may not be feasible, more so in times of economic downturns such as now. The panel has, therefore, suggested a two-year “regulatory forbearance” period for withdrawing the standard asset classification benefits now extended to restructured loans. 

In fact, it would help if banks themselves explicitly start recognising at least those loans as NPAs, which have suffered considerable diminution in their original ‘fair value’ upon restructuring. Relaxations in asset classification or provisioning norms are justified only in extreme crisis situations, when even solvent borrowers face temporary cash flow problems and banks must have the flexibility to grant some leeway.

 But in normal times, there is no case for any such regulatory forbearance.