Banks have to put in place proper risk-pricing mechanism, especially for funding long-gestation infra projects, if they want to prevent an encore of the present bad loan pile-up, Reserve Bank deputy governor NS Vishwanathan has said.
Banks are saddled with over Rs 10 trillion bad loans in the system, most of them in infrastructure sectors like power, steel and road projects, forcing the RBI to list as many 40 largest NPA accounts, which constitute 40 per cent of the mess, to be referred to the national debt tribunals for recovery and resolution in 2017.
He said in many instances risk is underpriced so as to demonstrate that a project would be sustainable, and hence would be good to finance.
“It would be safe to assume that had proper risk pricing been done, many of the current NPAs could have properly assessed very well,in advance,” Vishwanathan told a credit markets conclave organised by Care Ratings today.
The gross non-performing assets of banks rose by 18.5 per cent on an annualised basis in the September quarter to 0ver 10.2 per cent system wide or a little over Rs 10 trillion in absolute terms. And the regulator has projected it would cross 10.8 per cent by this March.
The deputy governor said once a creditor has decided to sanction a loan to a potential debtor, the next step for them is to arrive at a risk-adjusted pricing, and this is one area where banks needs to upgrade their skills.
“Risk-based loan pricing would need fair assessment and understanding of the risks involved rather than merely relying on collateral and/or guarantees obtained from stakeholders, including equity holders,” Vishwanathan said.
Banks should charge interest commensurate with the risks involved in the project that is being financed, he said.
Proper risk pricing will involves sophisticated assessment of risks and banks should be mindful of the stage of the business cycle in which the borrowers are in at any given point of time.
“Risk-based pricing will always help the banks to build buffers that could act as cushions in case of certain projects turn bad,” he said.
Vishwanathan said an important aspect of the loan is the covenants that include the terms and conditions of the project in the loan agreement.
He said banks should continuously monitor pre- specified trigger point in loan covenants to identify and rectify, if possible, early stress.
“It should be kept in mind that as the stress persists in an asset the expected value of recovery also diminishes. Therefore, this brings us to the need to act early when first sign of stress occurs in an asset,” he noted.
The deputy governor said in the Insolvency and Bankruptcy Code, the possibility of equity holders losing an entity should result in both stakeholders–creditors as well as debtor, to work towards resolution that is best for them.
Therefore, coordination mechanisms among banks, through institutional platform like joint lending forum (JLF) must ideally be deployed before the account is classified as special mention account (SMA).
“We have mandated JLF when the account is in SMA 2. I would rather suggest that moment the default happens, even a day or two, banks should start getting alert,” he said.
He said loan covenants need to be strengthened to deter the management of borrowers to take action to maximise their profits even it means at the expense of creditors.
Banks’s boards have to play a major role in enforcing the loan covenants through proper drafting of policies that would guide the man in charge and require to embolden the staff to take the decisions.
Lenders must protect their interest by writing strong covenants, strictly enforcing the covenants, properly pricing of risk and reacting to early warning signals about incipient stress that is building up, he said, adding “all this should be embedded into the credit culture of banks.moneycontrol