India's multi-billion dollar bad loans problem

Haircut-resistant Indian banks loathe a clean-up of their rotten loan books

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It’s common knowledge that public sector banks are in a mess. If the situation persists, not only will the banking system be in jeopardy putting further pressure on government finances, but also the economic revival everyone is counting on will be stunted. Who would know this better than the central bank governor Raghuram Rajan? No wonder, in the monetary policy last week Rajan said, “I want to put something like March 2017 on the table as when we hope that a full clean-up (of banks) will have been done.” The question is, can this really happen or is it wishful thinking?

A clean-up in the real sense can happen in only two possible ways. Either banks start taking sharp haircuts on their loans and get in new promoters, or the projects that are stuck start generating cash, on the back of a general turnaround.  

As things stand, banks have largely been averse to the idea of taking any haircuts on their loans. Analysts feel this is a bullet that banks need to bite sooner rather than later. “Not just PSU banks, but private banks would also need to take haircuts on their loans. The likes of ICICI and Axis continue to see slippages in their restructured books. For players like IndusInd, the coverage ratio has come down to 60% from 75%-80%. So, these banks also need to take some haircuts,” says Nitin Kumar, banking analyst at Prabhudas Lilladher.  

But, taking a haircut or appropriate provisioning is almost a taboo in a banking system where no bank chairman ever wants to dent the bank’s bottomline during his tenure. Thus, the weapons of choice are schemes that hide sticky stuff under the carpet. That’s the reason RBI’s new restructuring schemes — Strategic Debt Restructuring (SDR) and 5/25 — have been widely used.  

Under RBI’s guidelines, the invocation of SDR is not to be treated as restructured for the purpose of asset classification and provisioning norms. Thus, banks are exempted from any provisioning. Through the SDR route, lenders can convert their outstanding debt into equity and then sell off the company to new buyers. If bankers are not able to find a buyer for the asset within 18 months from the date of invoking SDR, the account slips back into NPA.

So far, bankers have invoked SDR towards loans amounting to ₹61,500 crore, lent to nine companies, of which three belong to the metals sector and the rest to power and other infrastructure. These companies are Lanco Teesta, Jyoti Structures, Monnet Ispat, Coastal Projects, Visa Steel, IVRCL, Shiv-Vani Oil & Gas Exploration Services, Electrosteel Steels and Gammon India. While SDR has brought down the provisioning requirement for banks, analysts say there remains a risk of incremental slippages going forward as they are not convinced that banks will be able to find buyers for these assets given the structural and macro-economic headwinds that these stressed assets face.

There are worries surrounding the 5/25 scheme too. Under this scheme, banks are again exempted from the 15% provisioning requirement if certain conditions are met. One of the riders is that the asset should not have had any restructuring in the past and should have been classified as ‘standard’ at the time of invoking the flexible restructuring package. It is not a surprise then that several of the accounts that remained out of the CDR cell are now getting restructured under the 5/25 window. This list includes the likes of Adani Power, Torrent Power, Jaypee Infratech, Uttam Galva Metallics and Vedanta. 

Banks have already refinanced over ₹100,000 crore worth of loans under the 5/25 window. Even if half of these loans were to be written-off, the entire FY15 bottom-line of India’s top banks would be wiped out. For now, the schemes are masking the problems. “Assets that would have otherwise slipped are not coming in. That is why the incremental stress seems lower,” says Kumar.  A large chunk of the stressed assets belong to the steel and power sector; it is the fortunes of these sectors that would determine the timing of banks’ own asset quality recovery.

While ‘Uday’ is seen as a positive for the power sector and debt-struck state electricity boards (SEBs), analysts don’t see a complete recovery transpiring in the next two years. Even if SEBs are able to break-even in 2-3 years as ‘Uday’ envisages, there seems little respite for independent power producers like Adani Power as they are unable to get compensatory tariffs and pass the higher coal costs. As on September 18, Indian banks’ exposure to the power sector stood at ₹580,000 crore, which represents 22% of the outstanding banking loans to industries.

As for steel, the fall in Chinese demand has led to a fall in international steel prices and with Chinese mills exporting a large part of their production at cheap prices to India and other markets, domestic steelmakers are facing tough times. “Steel demand is flat, import surge continues, even as exports fall, and the pain is now being broad based with more and more steel companies cutting production…at current realisations, we would expect more steel production to exit the system,” says Pinakin Parekh, steel analyst at JP Morgan India.

The 20% safeguard duty on imports of steel products doesn’t seem to be turning the tide for domestic steelmakers for now. The grim scenario seems grimmer in the context of banks as banks’ exposure to the sector stood at ₹290,000 crore, i.e. 11% of the total outstanding loans to industries.

While revival of these sectors is still in question given the fragile global economy and myriad local issues that still remain unresolved in sectors like power, banks may not be able to do any better than some cosmetic adjustments that camouflage the problems. Finding new stragic investors willing to buy these stressed assets may not be easy either.

As an analysis by Credit Suisse shows that some of the projects of the large stressed groups now have 20%-70% cost overruns pushing their capital costs even above replacement costs. With 30%-60% of their capacity still under construction, a large (15%-170% of P&L interest) is still being capitalised. With such bloated assets, banks will only find it difficult to find investors. The only option being taking substantial haircuts.

As per an estimate by Jefferies, the Government of India along with Life Insurance Corporation and General Insurance Corporation of India have lost $2.1bn out of $12.6 billion recapitalisation in the last seven years. That’s the cost of clean up. By 2017, the capital infusion packages would have funneled some more billions of taxpayers’ money into the coffers of public sector banks. Is that the clean-up Rajan is alluding to?