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Submitted By-

Group-2
Introduction & NPAs Recognition
• Government objective was to resolve challenge of large number of NPAs especially from
public sector banks (PSBs)
• Announcement of Recapitalisation was made with infusion of 2.11 lacs crore of new equity
in PSBs. Indradhanush Plan initiated by government in august 2015.
• Recapitalisation plan Decision:
1) Recognising Bad Debts & writing them off
2) Recognize the NPAs and avoid recapitalisation , successful effort “Fiscal consolidation”
• Unrecognised NPAs were large loans delivered by multiple lenders to big corporate groups.
•Corporate Debt Restructuring(CDR) – To devise turn around strategies for defaulting firm (
extending maturity plan, reducing interest rate, providing additional finance) and
Restructured standard assets
• The main idea was also to exempt bank from provisioning against loans that were bad and
would result in losses and eroded capital . This exemption clearly aimed to make sure credit
flowing is there to corporate(Capital Intensive Projects)
•The gap between declared NPAs and Stressed Assets widened to overcome this RBI declared
strict Guidelines for bad loans recognition.
•Recovery of NPAs of SCBs had fallen 22% in march 2013 to 9.8% by end march 2017
• NPAs reduction were stagnant between 2014-15(1,270 billion) and 2015-16(1,280 Billion)
•NPAs reduction is reported under 3 heads: Actual Recoveries, Transformation of NPAs, write
offs)
•The Ministry of Economic Survey 2016-17 argued that: the only alternative to cover debt to
equity is to take over companies and sell them at loss.
MACROECONOMIC SHIFT
• Neo liberal Macroeconomic policy reform focused on weakening the fiscal policies
that expand tax or debt financed state spending , and relying more on monetary policy
for managing liquidity and also adjusting interest rates
•Fiscal Responsibility and Budget Management (FRBM) act 2003.
•Prior liberalisation bank provide fund to industry and housing only to a certain extent,
as they were dependent on small depositors.
•Specialised financial institutions are there to provide long term capital from govt. Or
any other banks.
•Neo liberal policy bought change in provision of development finance, banking at that
time was: 1) the inadequate accumulation of own capital in hand of industrialist
2) Absence of markets for long term finance.
• Getting banks to be prime lenders created liquidity, risk mismatches
• Funds for the development banks came from multiple sources other than open
markets( the cost of lending capital was lower)
•Reverse emerged- The investors for capital intensive projects had to go again to
commercial banks for long term funding.
•There was distribution of financial assets among banks because of liberalisation and
the share of banks also increased from 61% in 2000 to 82% in 2012.
• Projects were undertaken by government as PPP and borrowed funds from PSBs
which created pressure for banks to lend money for such projects.
Consequences of External Liberalisation
• It lead to an increase in inflows in form of portfolio capital for
development.
• Foreign investment flows rose sharply from 15.7 billion in 2003-
04 to 70.1 billion in 2009-10, but there was a fall which was
because of Taper tantrum in 2013-14.
• Relaxation of sectoral ceilings on foreign shareholdings and
substantial liberalisation of rules and repatriation of profits and
capital.
• The increase in capital inflow surge liquidity in domestic
economy
• Flexibility : where bank accept deposit and lend that money to
corporate bodies
• There was a substantial increase in the loanable funds base of
the banks through periodic reduction in CRR and SLR by RBI.
Bank Lending to Industry and
Infrastructure
• The rapid expansion in credit required an expansion in the universe of
borrowers and the level of exposure per borrower, which implied
increased risk.
• There were also significant changes in the sectoral distribution of credit,
as banks sought to expand the volume of their lending and their universe
of borrowers.
• Overall, two sets of sectors gained in share.
• The first comprised of retail advances, covering housing loans, loans for
automobile and consumer durable purchases, educational loans, and the
like.
• The share of personal loans increased from slightly more than 9% of total
outstanding commercial bank credit at the end of March 1996 to close to a
quarter of the total more recently.
• Despite the huge increase in credit provision, the share of credit going to
industry stood at around 40% of total bank credit, not too far below pre-
reform levels of about 50%.
• The share of infrastructure lending in the total advances of SCBs to the
industrial sector rose sharply, from less than 2% at the end of March 1998
to 1696 at the end of March 2004, and as much as 35% at the end of
March 2015.
• Sectors like steel, power, roads and ports, and telecommunications were
the most important beneficiaries.
• For commercial banks, known to prefer lending for short-term
purposes, this turn to lending to infrastructure was a high-risk strategy.
• Since they were under pressure to lend, given the expansion in their
deposit base that resulted from the foreign capital inflow-generated
overhang of liquidity in the system.
• There appeared to be an implicit sovereign guarantee.
• The net effect of these multiple factors was a sharp increase in lending
to capital-intensive projects, including those in infrastructure, where
maturity and liquidity mismatches were significant.
• In practice, the failure of these projects/investments to generate the
revenues needed to bear the debt service costs associated with their high
debt to equity ratios, led to defaults, even in cases where much effort at
restructuring was made.
• Thus, underlying the V-shaped movement in the NPA ratio, was a post-
2003 credit boom and a structural shift in credit provision.
New NPAs (Non-performing assets)
• NPAs problems of the 1990s was substantially bad assets
arising in priority or non-priority sector loans to agriculture
and small industries.
• Between 1997 and 2003, the non-priority sector accounted
for around a half or a little more of NPAs in PSBs.
• Starting 2006, this share began to decline to 38% in 2008.
• The CDR scheme, which allowed banks to restructure large
loans subject to default.
• RBI instituted the assets quality review to reclassify assets
and reverse the practice of treating all restructured assets
as standard assets.(NPAs from 50%in 2012 to 77% by 2016)
• Post liberalisation, indian banks were on a pile of debt
directed at a few large borrowers, a larger share of which
was bad.
• some private banks were forced to declare a larger voume
of bad loans, the bulk of NPAs were on the books of the
PSBs.
• recapitalisatioin was urgent necessity because of fear of
insolvency and the meeting of basel guidlines.
• PSB must have atleast 52% govorment ownership of equity,
so that additional equity could be sold to private players.
• Private players diinot buy equity in banks that were burden
by NPAs.
• series of experiments such as attemt sales of bad asssets to
assets recunstruction companies, and segregation of bad
assets in a bad bank and selling some good assets &
business to cover losses.
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New Resolution Framework
 Once the asset quality review resulted in a spike in NPA ratios and
provisioning requirements, a new “Prompt Corrective Action”
(PCA) framework was devised.
 It specifies values of-
i. Capital to risk (weighted) asset ratio (CRAR)
ii. Net NPA ratio
iii. Return on asset values & leverage ratio
 These defines 3 levels of risk threshold, breaching any is called to
take corrective actions such as holding back dividend payment,
restrictions on branch expansion, etc.
 Soon banks were pushed to opt resolution framework offered by the
Insolvency and Bankruptcy Code (IBC) and the National Company
Law Tribunal (NCTL).
 The action has multiple components:
I. Large NPA’s have to be identified.
II. The consortium of banks holding those assets is given a deadline
by which the problem should be resolved.
III. For this, agreement in the Joint Lender’s Forum (JLF) of 50% of
the members involved & 60% of the value of the loans concerned
was adequate.
IV. Failing which, the banks were required to move to NCTL for
initiation of liquidation proceedings.
V. During those proceedings, the incumbent management was moved
out, the creditors were put in control of the process and an
insolvency professional appointed to assist the stakeholders.
VI. A resolution plan had to be in place within 180 days of referral to
the NCLT (additional 90days grace if required).
VII. If the plan is not agreed upon with the timeline, then the company
will go into liquidation.
 In the first attempt, the govt. notified 12 large NPA
accounts (combined debt of ₹ 2,26,400 crore) in
June 2017.
 There are three kinds of difficulties that the
process faces-
1. The opposition of debtors
2. Opposition from other third parties
3. Debt value higher than collateral
GOVERNMENT’s RESPONSE
• To tackle NPA’s government introduced Asset Reconstruction
Company / Corporation (ARC)
• ARCs are in the business of buying bad loans from banks and
earn by the difference between acquisition and sale price of
NPA.
• Government wanted to recapitalise banks.
• The banks could then raise capital from the market by sale of
public bank equity at reasonable price.
• The banks also chose to remain public with 51% equity owned
by government.
Cont…
• With the liberalization era , private banks became a
great contributor in restructuring of PSB ownership.
• In December 1993, SBI with paid up capital of 200
crore chose to go for public issue of shares worth 274
crore at par, but sold at a premium at 90 Rs per share.
• Out of 26 PSB’s , only 2 had private shareholding
with 40-49% range.
• With the emerging dilution in the next decade, banks
regained private ownership also extending to foreign
ownership of equity in 24 out of 26 PSB.
Financial Resolution and Deposit
Insurance Act
 The FRDI act was tabled in Parliament on 10th August 2017.
 The act seeks to create an independent FRDI Corporation
(FRDIC), which would take over the task of resolution of
failing financial firms from the RBI and other regulators.
 It is to be armed with special power to implement its mandate
and give control of the deposit insurance framework currently
managed by the Deposit Insurance and Credit Guarantee
Corporation of India.
 The govt. announced the Banking Regulation Ordinance,
2017, which introduced new clauses into the Banking
Regulation Act, 1949.
 This clause meant that the govt. could authorise the RBI to
take special action to resolve the bad debt problem. This would
involve forcing banks to launch proceedings against identified
borrowers to recover their unpaid dues.
 If no agreement for restructuring could be arrived between the
borrower and its lenders, liquidation proceedings against the
borrower were to be launched.
 This effort can at best be a partial solution, since, among other
things finding assets that can cover the defaulted loan is not
easy. So, even after recapitalisation, other majors of resolution
are needed.
 The resolution corporation is to be given the power to:
i. Inspect the books to obtain information on assets &
liabilities.
ii. Restrict the activities of the farm concerned.
iii. Prohibit or limit payments of different clients.
iv. Require submission of a restoration plan to the regulator and
a resolution plan to the FRDIC.
v. If identified as critical the FRDIC will take over their
administration and proceed to transfer their assets and
liabilities through merger or acquisition or to liquidate the
firm with permission from the NCLT.
vi. Since liquidation involves compensating stakeholders
according to their designated seniority, depending on the net
assets available, any stakeholder can be called upon to accept
a “haircut”.
 There are many implications to this act-
i. While the independent FRDIC and the concerned regulators will
determine whether a financial firm is to be placed in the material
or imminent category, the task of working out an acceptable
restoration or renewal plan rests with the firm under scrutiny.
ii. Since, mere categorisation in the material or imminent category
will send out a signal, banks so designated can become the target
of a run, as depositors fearing failure would want to move out their
deposits.
iii. The resolution plan to be acceptable may “force” the financial firm
to accept amalgamation or merger. And where resolution requires a
preferred strategy of “bail-in” of the firm, stakeholders, creditors
and if needed the depositors would be forced to accept a “haircut”
or loss.
Thus, the tabling of the FRDI bill is a clear declaration by the
government that it sees painful resolution or liquidation as a way
out of addressing the bad-debt problem currently faced by the
banking sector.

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