Financial Services
Monetary Policy Musings
17 Aug 2020

In the context of contracting GDP, anemic demand, tepid growth in bank credit, asset quality woes, cost-push inflation, and a fiscal under pressure, the 6th August monetary policy was a momentous one. Three announcements stood out for their potential repercussions: (i) rate action, (ii) way forward for borrowers, and (iii) new regulations for opening and operating current accounts.

Rate action

Doing nothing is sometimes more impactful than trying to do something. After a series of rate cuts, we have a surfeit of liquidity, sluggish credit growth, low-risk appetite of banks, and a negative carry on incremental deposits. Demand is unlikely to be boosted by additional rate cuts. The CPI inflation in June was 6.1%, and even assuming some moderation, it is much higher than policy rates. The status quo was probably the only option.

The way forward for borrowers

This one was a much tougher call – one argument is that it is better to call a spade a spade, and so let loans be classified as NPAs if borrowers cannot service their loans. However, we do not have a good sense at this point in the scale of the asset quality issue: GNPAs can rise by 50%, and in a pessimistic case, double from FY20 levels. Many banks could find themselves falling short of capital thresholds and invoking the PCA framework - effectively getting shut out of the market.

The RBI’s approach is to allow banks a window to provide relief to COVID-impacted borrowers by restructuring their loans (subject to certain conditions), report these as standard loans but make some provisions (though lower than if they were NPAs). There are three questions: (i) how to identify COVID-impacted borrowers, (ii) how much concessions should be provided, and (iii) what should be the governance framework for the scheme.

Eligible borrowers for restructuring

The policy states that borrowers who had at most 30 days past due on 1 March 2020, but since then have been unable to service their loans can be said to be impacted by COVID and would be eligible for the restructuring. These could be retail, MSME, or corporate (but not agri) borrowers – this is the first time that retail loans are permitted to be restructured without classifying them as NPAs.

Concessions to eligible borrowers: Lenders can extend the tenor by up to two years, subject to approval by 75% of lenders by value and 60% by number. The scheme has to be signed off by 31 December 2020 and implemented in a time-bound manner, failing which, the concessions of this scheme will not be applicable. The key change is that the loan can be classified as standard even if there is no change in the ownership of the borrower.

Governance framework

The RBI has announced the appointment of a committee to decide the framework including benchmarks for various sectors and review cases where the exposure exceeds INR 1,500 crores. A reporting format has been prescribed for making relevant disclosures.

Several issues of merit discussion

Firstly, restructuring of retail loans is a first and comes at a time when lenders had started to leverage bureau data. This scheme is almost certain to distort the usability of data going forward. Secondly, having a regulator-appointed committee to set the rules and even vet cases is moving from normative regulation to prescriptive regulation. The Indian banking system had long moved on from a world where the regulator prescribed everything to one where they made decisions based on commercial judgment. Finally, given the provisioning arbitrage, what is the assurance that the mistakes of the previous restructuring cycle would not be repeated?

New regulations for opening and operating current accounts: Private sector and foreign banks have implemented cutting-edge technology solutions to help businesses manage their funds effectively and enjoy a disproportionate share of current account balances. The policy’s impact on current account balances will be profound – not only would the pie shrink, but it will also be redistributed in favor of lenders. This could have major implications in the SME/mid-corporate segment where the lenders are mostly PSU banks, while private sector banks enjoy the current account.

The intent of plugging diversion of funds is absolutely correct, but the proposed approach will lead to a lot of issues. Will customer convenience take a backseat – why should customers not get the best products and solutions and be tied, instead, to their lenders? Several transactions will become very inconvenient, e.g. a lender having 5% share in the exposure who has issued a letter of credit will have to arrange for the payment from the escrow banker. Does this policy ensure that there will be no diversion of funds – would it not have been better to build an information-sharing mechanism amongst banks?

Policymakers have a tough job, and the COVID crisis is making them choose between options, each looking worse than the other. The RBI is respected for its track record of steering the economy and the banking system away from trouble. Let us hope that its good run continues!

Authored by:

Shishir Mankad, Practice Director, Financial Services

This post first appeared on ET BFSI and has been published with permission. 


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