Viral Acharya, the new Deputy Governor of the Reserve Bank of India (RBI) suggested last week that loans restructured by banks be rated by at least two rating agencies. The idea is certainly worth a try. (Actually any idea is worth trying if it can help resolve the threateningly large load of bad loans).
Currently, there is, in a sense, some mistrust between bankers and RBI. Bankers have eloquently argued that the tools provided by the RBI to restructure bad loans or non-performing assets (NPAs) have unrealistic caveats. For instance, the S4A or scheme for structuring of stressed assets allows banks to mark up to 50 percent of a loan account as unsustainable. This presents two problems: one, some loans require a larger portion to be marked as unsustainable. Two, even less stressed borrowers are demanding that bankers give them 50 percent loan forbearance. The other caveats of the S4A scheme are: banks cannot change the rate of interest, they cannot reschedule loans already due and they can take into account only six month forward of expected commercial output.
On the contrary, if banks were to restructure loans outside the S4A scheme, they can’t get provisioning forbearance for the sustainable part of the loan. More important, the Indian Banks Association’s overseeing committee won’t vet their process, leaving them open to future charges of cronyism. More generally, banks want greater freedom to restructure, more time to provide for the loss to their NPV (net present value) and more safeguards from criminal investigation of commercial decisions.
RBI is rightly circumspect. The general permission to restructure loans in 2010 was widely used by banks and promoters to evergreen patently unviable loans. The 5:25 scheme that allowed banks to stretch out loans to 25 years or to the economic life of the asset was also misused, after the several tweaks demanded by bankers and granted by the regulator.
In this tug of war of trust, the deputy governor’s suggestion that rating agencies must play referee for all large loan recasts seems like a great idea. Let me reproduce his thoughts:
*Each resolution plan should get vetted and rated by at least two credit rating agencies.
*Rating agencies should assess the financial health (interest coverage ratio, leverage, etc.), economic health (sector, margins, etc.), and management quality (promoter or the new team).
*The rating would be for the asset and not just for bank debt in case additional debt is issued under the plan.
*Feasible plans would be those that improve the rating of the asset.
*The minimum of the two credit ratings should be at least just below the investment-grade level.
This idea appears to have several advantages. Firstly, it doesn’t require banks to start all over again. Bankers have done a lot of work on some assets, The T’s can be crossed and I’s dotted right away and sent to rating agencies. Secondly, and more importantly, rating by an independent agency will ensure that banks are not kicking the can down the lane. It will ensure the restructuring is deep enough for the loan to turn sustainable. Thirdly, such ratings may give banks more power to bargain for fresh equity from the new investors or the old promoter. Fourthly, it may resolve the problem of fear of mala fide accusations that is now paralyzing the system.
Some asset reconstruction companies and private equity players have argued that rating agencies are not needed when a loan is anyway not going to be listed and the players (bankers, ARCs, and other new investors) are eminently capable of doing their own diligence. This argument misses the point. A lot of tweaks to the restructuring rules is not being allowed by RBI primarily because it fears the ARCs, private players, promoters and bankers may form a cosy club. When a rating agency like S&P or Crisil or Moody’s or Fitch puts its reputation on the line, it will remove suspicions of cronyism.
Some experts have argued that rating agencies only rate specific loans, whereas this plan wants them to rate a business. World over, rating agencies do rate scenarios before mergers or corporate restructurings and this is done in India, too. Rating agencies privately do give their opinion on a proposed corporate restructuring. In these NPA revamp cases, the opinion could be initially private and then made public when the deal is signed and sealed.
If the rating is made mandatory for all loan restructurings above a certain limit (say Rs 500 crore), the regulator too may be more willing to consider more forbearance, since there will be comfort that the process is not misused to evergreen or postpone loans. The rating agency as referee also obviates the need to send all cases to the IBA oversight committee.
Of the many ideas on the table, this one seems most wire-ready. Hopefully, banks and the RBI will formalize the idea quickly.