The stressed assets problem plaguing Indian banking system is well documented. Gross non-performing asset (NPA) ratio for banks is at their peak and the problem seems to show no signs of abating. The question to ask in such a scenario is how big the actual problem is and what does it entail for the banks? To give an estimate, there are nearly Rs 12 lakh crore of stressed assets in the country’s banking system.
These constitute nearly 15 per cent of the outstanding loan books of these banks. Of this, banks have already sold around Rs 2 lakh crore worth of such loans to asset reconstruction companies (ARCs), leaving about Rs 10 lakh crore on their own books. Taking the past experience into account, nearly 35 per cent or Rs 3.5 lakh crore of the Rs 10 lakh crore will eventually need to be marked down by banks in the form of provisions and write-offs.
These numbers reflect a massive problem which requires a concerted and strong response. The Reserve Bank of India (RBI) and the government have gone about solving this in a very phased and planned manner. They have identified that the problem is of gigantic proportions and a one-shot resolution would serve no purpose and could potentially yield disastrous consequences. The response has evolved over the couple of years through a variety of steps, each designated to further push towards a clean-up in the banking system.
Asset quality review
The process started in 2015, with the AQR undertaken by the RBI. This pushed the banks towards transparency in recognition and classification of NPAs across the board. While this resulted in significant provisioning by banks and decline in profitability, it also established a clear picture of the nature of problem faced by the banks. The good news is that banks have already provisioned Rs 2 lakh crore of the Rs 3.5 lakh crore markdown they are expected to take on their stressed loans. Effectively, more than half the markdown is already over. Additionally, banks are now providing around Rs 35,000-40,000 crore every quarter. Usually, it takes 3-5 years for the provisioning and ‘real value’ to catch up. So, the required provisioning should be complete in another 4-5 quarters. This will effectively complete Phase-I where the mark to market for these stressed loans will be accomplished.
Restructuring and NCLT
With the provisioning requirements almost taken care of, the time is now opportune for banks to aggressively get into restructuring mode. The economy, global as well as Indian, is also on an uptick, creating an amenable environment for promoters to agree to reasonable restructuring terms. This is because promoters also now see the potential of an upside in case the restructuring works out. This is in contrast to a couple of years ago when the relatively weaker growth meant that the promoters could afford to wait and drive a harder bargain as restructuring presented no viable benefits for them.
In such a scenario, the RBI direction on referring companies to the National Companies Law Tribunal (NCLT) could push the NPA clean-up process into its end-game. While the modalities to this are being worked out, the process has already been initiated for a few cases. Assuming most cases will be referred to the NCLT by October 2017, we could expect most resolutions/ restructurings to be in place by June 2018.
According to our estimates, more than 70 per cent of these cases will be restructuring and resolutions wherein the debt will be written down to sustainable levels. Banks will take equity positions in these companies and new investors will provide additional capital. These companies would be then run with higher governance oversight and stricter loan covenants. As banks will take debt haircuts, promoters will take significant equity haircuts and new investors will ensure better management of these companies going forward. Capital allocation and efficiency will be the key for these companies as they try to tread back the path to normalcy. We estimate that around Rs 40,000-50,000 crore of new additional capital will have to be infused to make these companies perform efficiently again. This will be infused by a mixture of existing promoters, ARCs, stressed asset funds and private equity (PE) investors. These investors will also drive the turnaround for these companies through stronger oversight.
Driven by the strengthening economy and pushed by the government, regulators, banks and capital providers, we expect the bad loan situation to be significantly mitigated by 2019. The economy can then look forward to a fresh capital expenditure cycle. Coupled with strong consumption & savings, continued seminal reforms like the goods and services tax and aided by the continued trend of global capital flows, we can expect to see the Indian economy firing on all cylinders in the next few years.