IBC No Holy Grail
While banks exist to manage risk and thus, loans will go bad in future as well, a robust and independent credit assessment and monitoring process will ensure that banks asset quality remains under control and banks are capitalised for growth rather than bad debts
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Over the last 12 months, the Indian banking industry has been busy understanding, interpreting and implementing the Insolvency and Bankruptcy Code (IBC). It is not surprising given the growing proportion of non-performing assets (NPAs) of banks (almost ten per cent of total advances as on 31 March, 2017). While introduction of the IBC is an important reform and can have a significant impact on the way business is done in India, it is only one of the tools bankers have for managing their asset quality problems.
A deeper analysis of the NPAs suggests that the problem lay in origination and monitoring and not necessarily recovery. With the country expecting a pick-up in economic activity in the near future, banks will once again be building their balance sheets and funding both good and bad assets. Kroll has worked closely with the banks (both public sector and private) during the current NPA crisis and strongly believes that banks have learnt from their mistakes and are set to implement better principles.
Improving the credit assessment process is the very first step. While banks have a detailed credit appraisal process in place, unfortunately it focusses and relies heavily on the information disclosed by the borrower. A more insightful and independent assessment would not only have saved the banks crores, it would have helped them maintain their credibility and reputation too. Regulators and the government are equally to blame for this mess. The recent announcement on bank recapitalisation also talks of the need for an independent due diligence in the credit process and reflects North Block’s seriousness about asset quality.
It is also something that the banks can learn from their nemesis, the NBFCs. For over two years now, while banks were busy addressing their asset quality woes, NBFCs have been active financiers to corporate India, and more specifically to the riskier ones. However, despite the high risk, the portfolio quality has held firm and has also yielded handsome returns. The key driver behind this is the time invested by NBFCs in understanding their borrowers and their promoters, both directly and through third party diligence. The second important factor is the ongoing monitoring of the portfolio.
A couple of years back, the RBI had made it mandatory for banks to disclose Special Mention Accounts (SMAs) with three buckets — SMA 1 (0-30 days overdue), SMA 2 (30-60 days overdue) and SMA 3 (60-90 days overdue). However, SMA classification has been reduced to a reporting number with very little being done to address the asset quality deterioration. A closer look at the reasons behind an account unexpectedly becoming SMA, especially through an independent review (especially on growing debtors, related part transactions, etc.) will help identify a fraudulent borrower at an early stage.
This will also ensure that the bank is not taking fresh exposures to fraudulent accounts and significantly reduce the cost of recovery. In addition, periodically reviewing the collaterals provided by the borrowers is a good practice and ensures that the bank always has adequate cover against its exposure. However, there will always be borrowers who believe they are smarter than the system and don’t disclose much to the banks during good times. For such wilful defaulters, banks should initiate an asset search exercise rather early in the recovery process. Most wilful defaulters are happy letting the company suffer while enjoying a comfortable lifestyle.
While banks exist to manage risk and thus, loans will go bad in future as well, a robust and independent credit assessment and monitoring process will ensure that banks asset quality remains under control and banks are capitalised for growth rather than bad debts.
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