Experts believe the financial industry is still not mature enough to deal with aberrations, and wants special treatment to minimise the impact of negative deviations on its balance sheets. Regulators are left to come up with prescriptions that have often run afoul of legal scrutiny.
One such recent example is the February 12, 2018 circular of the central bank, a directive struck down by the country’s highest court. Now, the onus is on banks to take defaulting companies into administration, and orders can’t come exclusively from Mint Road.
“Regulatory forbearance should not become a regular practice unless a situation like 2008-09 happens, which was a global phenomena,” said Kuntal Sur, financial risk and regulation leader at PwC. “Whenever there is a systemic risk, the regulator has to step in and not because of idiosyncratic risks.” Of course, the case for forbearance also arises in case of natural calamities, Sur said.
In the Essel and IL&FS cases, mutual funds have sought leniency to ensure the net asset values of their units don’t plunge.
The good, the bad, and the ugly
The market regulator has allowed splitting of a mutual fund unit into bad and good portions when part of the investment of a mutual fund goes sour. After IL&FS was downgraded from AAA to D within 45 days, investors in schemes with exposure to the group were left holding the equivalent of junk debt. Now, funds have the option to write down the value of the holding, either partially or fully.
“Forbearance has to be aligned with the objective of investors,” said JN Gupta, former ED, Sebi. “It cannot be given to beat the competition. Forbearance cannot be on individual company basis and can only be allowed if it is not individual fund-related situation but industry-wide situation. Loss to investors will be permanent if mutual funds sell IL&FS papers. If it is market wide and in the interest of investors, rules can be tweaked.”
After the IL&FS default, insurers have written off around Rs 7,000 crore of debt exposure. Many of them have provided for their exposure to IL&FS in the third quarter when the default started.
IL&FS started with idiosyncratic risk and has expanded to sub-sector risks. Regulators have to look at the system wide impact. The challenge has to be dealt differently if it is affecting liquidity, forex and borrowers at large. Some insurers approached Irdai to give them more time to comply with passive breach in Ulips funds after a spate of downgrades.
Stability key to decision-making
“Efforts have to be made toward keeping the system stable,” said Janmejaya Sinha, chairman, BCG India. “You have to think about the needs of the economy — How do we get this to operate.”
Should exemptions follow individual assessments?
Central bank norms require promoters of private banks to reduce their holdings to 15% within 12 years of the start of operations, which in Kotak’s case would mean by March 31, 2015. Because of special forbearance, Kotak holds around 30% in the blue chip bank. When Mint Road did not give further extensions beyond the December 31, 2018 deadline, Kotak issued preference capital to lower promoter stake in paid-up capital. When the regulator rejected it and issued the bank a show-cause notice, Kotak filed a writ petition in the Bombay High Court, requesting a stay on the central bank action.
“If RBI can exercise discretion, it should,” said Sinha of BCG. “…We do not have consistent norms on the definition of a holding company.”
Three largest private banks — ICICI, HDFC and Axis — are in effect foreign owned. If there are sanctions imposed by the US, there would be a huge impact on the banking system in India, said Sinha.
Former central bank governor Urjit Patel had likened moves such as badloans resolution recognition to the mythical churning process of Samudra Manthan.
“I do wish more promoters and banks, individually or collectively, through their industry bodies would reconsider being on the side of Devas rather than Asuras in this Amrit Manthan,” he had said.
The bad loan pile
Regulatory forbearance was cited as the reason for mounting bad loans. Rising NPAs forced RBI to put in place a harmonised resolution for stressed assets, replacing all other schemes of restructuring. The end of March 31, 2018, saw non-performing loans spike to 12.1 per cent of advances, or Rs 10.35 lakh crore.
Banks had been ever-greening stressed accounts through restructuring schemes. Credit debt restructuring, structured debt restructuring, S4A were part of concessions to extend the pain. The fear was that withdrawal of regulatory forbearance on asset classification would lead to difficulties for borrowers to arrange additional financing. So, NPAs rose from Rs 2 lakh crore in 2013 to Rs 10.35 lakh crore in 2018.
Regulators will have to evaluate the impact of regulatory actions. In case of regulatory violation that was not intentional and for overall benefit of investors, an exemption can be made. But it should not become the norm for individual loan decisions gone sour.