View: What can governor Shaktikanta Das learn from Subbarao’s mistakes?

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Duvvuri Subbarao as Governor of the Reserve Bank of India did what central bankers across the world did after Lehman Brothers Holdings blew up – slash interest rates, flood the market with liquidity and be generous with forbearance. His dilemma later was when to pull the steroids? He equated himself with the warrior in Mahabharata – Abhimanyu – who was trapped to death in Chakravyuh – a circular battle formation.

As the payment moratorium deadline draws closer, Governor Shaktikanta Das’ dilemma may be no different from Subbarao’s. How to exit the Chakravyuh? The industry chorus for a one-time loan restructuring, if granted, is set to pull him in deeper than allowing an exit.

Few would dispute that businesses are in pain. The lockdown to fight the Coronavirus has vaporised cash flows and made debt servicing difficult. What are the lessons and options before the regulator?

Stalwarts like HDFC Chairman Deepak Parekh and State Bank of India Chairman Rajnish Kumar are saying that moratorium is contaminating the payment culture. But many are for loans restructuring.

If Indian banking ranks as the worst in the world in bad loans, one can without hesitation point a finger at the Corporate Debt Restructuring programme that banks followed before the Insolvency and Bankruptcy Code came into force in 2016. Restructuring became a tool to paper over the rotten assets rather than reviving struggling businesses.

Banks hid the losses and entrepreneurs continued to run businesses inefficiently as loan repayment tenures got extended and interest rates reduced. The programme was an incentive to default. Promoters hardly brought in equity and banks bore all the burden. The repayment schedule rarely matched cash flows. State-run banks bore the brunt with no access to private capital and taxpayers stumped up more than Rs. 3 lakh crore in capital. If restructuring comes back, other scenes of the drama would play out as well.

Any discretionary measure by the regulator would be open to questioning just like its permission to restructure loans to aviation companies. Furthermore, the stress in the system has been building up even before Covid-19 struck and many would use that as an excuse to escape prudence.

RBI’s latest Financial Stability Report captures the state of affairs.

The number of rating downgrades in fourth quarter of fiscal 2019 rose to about 2,000 from just 500 in the first quarter of fiscal 2017, says the RBI report. It soared to nearly 4,300 in the fourth quarter of fiscal 2020 reflecting the stress before the declaration of moratorium. What is alarming is that even the better rated companies are unsafe.

“The ratings distribution of performing portfolios that are vulnerable (Special Mention Accounts 1 and SMA 2 categories) also throws up ‘AA’ and above as the largest rating grade, implying that not all higher rated obligors are impervious to shocks/risk aversion,’’ says the report. SMA accounts are those that missed payments, but are yet to be classified as bad loans.

An extension of moratorium and ad-hoc restructuring can undo the gains made so far. PSU banks with weak capital and risk aversion account for just 67 percent of outstanding loans, down from as high as 75 percent a few years ago. If they have to remain relevant, they need to recognise the bad loans, take losses and raise private capital.

One way of imposing discipline is to direct banks to use its June 2019 order to treat defaults and the IBC to workout resolution plans.

Suspension of the IBC may have been done in haste, but that’s probably the best tool available to resolve any impending crisis. If JC Penny and Hertz could file for bankruptcy in the US during Covid, there’s little justification for Indian defaulters to get a different treatment.

Governor Das’ decision would determine whether we go back to a past that hobbled banks and favoured the inefficient, or a rules-based future that strengthens the financial system.

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Tagged coronavirus, IBC, interest rates, Lehman Brothers, Rajnish Kumar,

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