Default and be merry

BL : R Visanathan  Former Deputy Managing Director, SBI.:24 Sep 2013

The new RBI Governor Raghuram Rajan has mentioned 

that “we (RBI) will take a close look at corporate distress and bank NPAs to … 

accelerate the process of resolution”.

The truth is that this is a messy affair. 

Regarding NPAs (non-performing assets) it is no secret that sovereigns in India (both Central and State) rarely, if ever, honour their financial guarantee obligations to banks and others.

Their example is faithfully followed by some banks and their borrowers, too.

The RBI has been a silent spectator so far.

 I request the RBI to take up the matter seriously at various levels.

Many NPA advances of banks are guaranteed by the promoters, including sovereigns. 

When the advance turns sour, guarantors blithely renege on their liability.

In recent memory, no businessmen of stature has gone bankrupt because he/she failed to repay the debt guaranteed by him/her.

Among banks themselves, there have been defaults arising out of letters of credit, a structured and codified obligation.

If the amount is substantial, the guaranteeing bank refuses to honour the L/C liability on some pretext.

The matter invariably goes to the courts and is allowed to drag on for years, if not decades.

SOVEREIGN SLIP-UPS

Sovereigns are no different as guarantors. 

In my long service at a premier bank in the country, I saw

only one case about 40 years ago when a bank forcibly recovered the

 guaranteed amount from a State government account.

When a financially troubled public sector company raises a loan from a bank or floats a bond, the owner government issues a guarantee covering the obligation. 

When the borrower inevitably defaults, the guarantor refuses to pay.

Around six or seven years ago, a government company failed to repay, on maturity, the amount of bonds issued by them; this was guaranteed by the Central Government, which too did not pay.

The credit rating agency that rated the bond ‘AAA’ earlier because of sovereign cover, promptly downgraded it to default category.

Lest this be treated as a black swan event, let me mention that the RBI is fully aware that default by sovereigns is the norm, not the exception.

The annual master circular issued by it on the subject in July 2013 states:-

 “The credit facilities backed by guarantee of the Central Government though overdue may be treated as NPA only when the Government repudiates its guarantee when invoked… State Government guaranteed advances and investments in State Government guaranteed securities would attract asset classification and provisioning norms if interest and/or principal or any other amount due to the bank remains overdue for more than 90 days.”

So, the RBI acknowledges that sovereigns can and do renege on their guarantee liabilities.

On a broader plane, a guarantor will default if he is unwilling or unable to pay. A sovereign’s inability to meet local currency debts is certainly unacceptable.

If it is unwilling to pay, the implication is that the law-maker becomes a law-

breaker.

Such defaults by sovereigns even for rupee liabilities, you will agree, does not bring any credit to the country.

SOME SUGGESTIONS

To improve this sad state of affairs, some steps can be taken.

First, the RBI could effectively and promptly intervene when a bank dishonours an letter of credit liability and make the defaulting bank pay without court intervention.

Second, the RBI could make all state governments pay their obligations to banks promptly in respect of NPAs guaranteed by them. The RBI did intervene and protect banks on an earlier occasion. A few decades ago, some of the financially distressed State governments did not even pay the interest due on their sovereign bonds.

The RBI took up the matter strongly with them and ensured that the amounts due were paid even, if needed, by recovering from the fresh borrowings of the government concerned. 

A similar mechanism should be evolved for State 

government guaranteed loans.

As for Central Government guarantees, could the RBI at least ensure that the interest due on these advances is paid on time?

In conclusion, the RBI instruction to banks (quoted above) does little credit to the country. 

The earlier it is rendered unnecessary, the better.