New credit cycle about to begin; some pitfalls to avoid

Economies move in cycles. NPA cycles in banks reflect movements in economic cycles. Over the past 3 decades, GNPA in banking systems has peaked at around 10% to 14% of gross advances and bottomed out at around 2% to 4% of advances.

India is now out of the last economic cycle. Indian corporate balance sheets have never been stronger. Bank balance sheets are strong. India is well placed to start a new cycle of credit growth, the pandemic and recent geopolitical issues have only slightly dampened it.

In 2018, at the aggregate level, the GNPA for the entire banking system peaked at Rs. 10.4 tons. As India’s economy grows from $2.5 billion to $5 billion and then to $10 billion, all stakeholders from RBI to IBA to credit providers etc. must embrace reforms, technology and building on what worked well and learning from the mistakes of previous cycles.

As Winston Churchill so aptly put it ‘Never let a good crisis go to waste” I firmly believe that all stakeholders have had their fair share of lessons learned from recent major cycles – the GFC of 2008 and the bear cycle of early 2013.

There is a staggering difference in GNPA levels between different classes of banks viz. in 2018, when GNPA levels peaked, GNPA levels were 14.6% for PSBs compared to 4.6% for private banks; a command of 3.2x times in the PSU banks. Within private banks too, there is staggering variance, with GNPA levels in 2018 at 1.3% in HDFC Bank, 2.0% in Kotak on the one hand and 8.8% in ICICI and 6.8% in Axis, the peer banks. . Which leads us to say that there are definitely variables/controllables that some lenders manage better than others.

Some of my views that hopefully reduce NPA formation in the first place and some suggestions once an NPA is formed, some education/support, rejuvenating the asset and finally getting it happens at all in the recovery stage, a few changes that can go a long way towards efficient and better recovery for lenders.

Loan – Credit Assessment and Monitoring

Better credit scoring, intensive use of technology, proportionate covenants and proactive monitoring can help reduce the formation of NPAs. Lenders should ensure/facilitate

  • Using technology for triangulation of vendor, customer, warehouse, lender, GST data to weed out/prevent gold plating, fictitious and overfunding borrowers
  • Working capital financing must be “controlled financing”; for inventory – warehousing and tracking by third parties and for receivables only against L/C
  • The lead lender (LL) should be the lead in the truest sense, with LL being the sole decision maker for a quick and better decision and putting in place an effective follow-up framework tailored to the borrower. Other lenders simply participate in lending on a reward and risk-sharing basis. Eliminate at all levels the duplication of decision-making, process, follow-up, etc.
  • In any LL project funding to ensure –
    • all project cash flows, including equity contribution, controlled through an escrow account;
    • bifurcation of functions – project evaluation, sanction, follow-up during implementation and credit follow-up after DCCO. Build internal sector expertise. Continuity of core evaluation and monitoring team throughout project implementation period with KRAs, accountability and incentive structure;
    • Rigorous risk assessment and mitigation – all full approvals/permissions/fixings must be mandatory PCs (land acquisition, right of way, environmental clearance, fuel bond, PPA, Take or Pay, etc.);
  • Lenders need to build a knowledge repository to have a top-down view of all funded projects to avoid creating overcapacity in any sector.
  • No captive EPCs for the creation of infrastructure assets – in the last cycle a major source of NPAs – whether there are separate players for the construction and ownership of these assets
  • Enabling ecosystem – Government (stability of policies, sanctity of contracts, release of timely payments), independent agencies (ranking and blacklisting mechanism)

Insolvency and Bankruptcy Code (IBC)

The IBC has been the foundation of NPA resolution since its enactment in 2016. There is certainly room for improvement in the IBC both in terms of the time it takes (currently on average >500 days) to resolve a cases and for better recovery from a CD (on average 33% HR). Some thoughts to bring more efficiency-

  • Model the resolution plan – to eliminate disputes and save a lot of time – RA just needs to fill in its DDs and provide the value for the corporate debtor (CD)
  • IBC had envisioned u/s 7 a CD would be admitted within 14 days of filing with NCLT, we now know this takes practically months. In all cases of defects, verified by the CRILC, there should be an automatic admission and all other matters can be heard simultaneously by the NCLT
  • In large CDs there are competitive bidders, for medium and small CDs there are not many takers. In such cases, in the absence of genuine participation, the payback for the CD is relatively lower. The Supreme Court established the maximization of value as a principle for lenders. Former promoters, in cases where there is no fraud and they are not voluntary defaulters, may be allowed to participate in the IBC process, on a cash offer basis, which will lead to better recoveries

The GOI and RBI have demonstrated their determination to cleanse the banking system to a large extent from the scourge of the NPA. The economy today has healed from the excesses of the past. Learning for all stakeholders has been very expensive. What is most important is that in the next credit cycle, India would hopefully build much more infrastructure, of a much greater magnitude and on a much larger scale on a more durable basis.



The opinions expressed above are those of the author.