Fears of risks in bail-in move remain

The criticism apart, the praise poured by these bodies that India is deemed by the IMF to have a systematically important financial sector meant that it has little option other than getting itself subject to the Financial System Stability Assessment (FSSA). This joint programme of the twin institutions of post-War creation spawns out every five years a comprehensive analysis of a country's financial sector since September 2010. In its second Financial Sector Assessment Programme (FSAP), put out on December 21 in Washington, the Fund has blared the bugle after its Executive Board approved India's 2017 FSSA, by stating point-blank that "high non- performing assets (NPAs) and slow deleveraging and repair of corporate balance sheets are testing the resilience of the banking system and holding back investment and growth".

For the domestic authorities groping in the dark to fathom the slowdown of the economy and the tepid private sector investment activities to rev up the real sector machinery at least to half throttle, if not in full throttle, the continued delay in finding a solution to the twin balance-sheets woes of banks and corporate firms straddling the economic landscape risks threatening to perpetuate the problems plaguing the economy going forward. The banks, which lent to the corporate firms in boom times by firing their advances bazooka like a wild elephant running amok is what led to the twin balance-sheets troubles that roil the real economy now. As per the RBI data, gross non-performing assets (GNPAs) of public and private sector banks as on September 30, 2017 were Rs 7,33,974 crore and Rs 1,02,808 crore respectively. As on that date, leading corporate houses/companies accounted for roughly 77 per cent of the aggregate GNPAs from domestic operations for scheduled commercial banks! Sardonically, banks and corporate firms' symbiotic ties are coming apart at the seams!

No doubt, in conceding the relevant point that India's key banks appear resilient and that the domestic financial system is undergoing a gradual structural shift with a greater role for non-bank intermediaries and higher recourse to market funding for large corporates, the Fund bears out the obvious reality that financial system assets equal about 136 per cent of GDP, close to 60 per cent of which reflects banks' assets! Given the fact that the state retains "an important footprint in the system via ownership of large financial institutions, captive government financing and directed credit to priority sectors", the system is axiomatically "subject to considerable vulnerabilities".

Taking due note that the authorities have been adopting policies to accelerate the process of NPA resolution, it said the 2016 Insolvency and Bankruptcy Code (IBC) injected a modern framework that aims at reorganisation and insolvency resolution in a time-bound way. Besides, the Reserve Bank of India (RBI) was empowered with directing restructuring cases to the insolvency process. Pertinently, the Fund directors were of the view that this tack shows promise to deliver progress in NPA resolution, particularly "if accompanied by sufficient upfront provisioning and capital buffers in the PSBs, broader restructuring of the PSB sector, including improvements in governance; more flexible out-of-court debt restructuring mechanisms; and increased capacity and resources for the insolvency courts". The Fund also took due note of the fact that the Indian authorities recently unveiled a recapitalisation plan for the PSBs amounting to approximately 1.3 per cent of GDP (roughly 2.1 trillion of rupees), as well as the establishment of a mechanism to seek consolidation across the banks. To boot, the government also announced the setting up of an alternative mechanism panel, headed by Union Finance Minister Arun Jaitely, to seek consolidation across state-owned banks.

Here a caveat is a par for the course from the perspective of multilateral lending bodies which pitch in for "a clear plan to deal with PSBs that will not be able to attract private capital". This perspicuously points to the need to have a provision of public capital for recapitalisation predicated upon "meaningful restructuring of PSBs and exit of weak banks (via sale of viable assets and liabilities to stronger public and private sector banks) should be considered". This is important, as per the IMF/World Bank assessment, because consolidating weak PSBs into stronger ones "risks undermining the viability of the acquirer". This is easier suggested than accomplished, given the vociferously organised bank employees unions! However, the other proposals, such as improving PSBs governance, as set out in the Indradhanush Plan, needs to be "firmly pursued to enable qualified senior management and Board members to be appointed for extended mandates, strengthen risk management and limit the scope for government interference"

At a time when the proposed Financial Regulation and Deposit Insurance (FRDI) Bill is before a Joint Panel of Parliament to study its various provisions including the setting up of a Resolution Corporation (RC), which is proposed to provide for the resolution of certain categories of financial service providers in distress, deposit insurance to the depositors of an insured service provider up to a specified limit and protection of public funds for ensuring the stability and resilience of the financial system, the FAAS rightly stated that India currently has no provision for the same. FAAS conviction that only a consensual, hybrid form with both statutory and contractual forms of bail-in may be suitable for India" has not factored in the strong and stout resentment to the bail-in provision had drawn, forcing the Prime Minister and the Finance Minister to assure the public that their deposits with banks are safe.

Already, former RBI Deputy Governor Usha Throat voiced the ubiquitous concerns on bail-in clause baying for depositors' savings when she wrote in a leading mainstream daily that it is unclear how the bail-in provision is tenable with the implicit sovereign guarantee underlying bank deposits. In fact, she cited the Working Group on Resolution of Financial Institutions by the Financial Stability Development Council (FSDC) favoured excluding deposit liabilities, inter-bank liabilities and all short-term debt, which if subjected to bail-in, can spur financial instability. Incidentally, the FRDI Bill is founded on the broad contours of suggestions made by this Group.

At the end of the day, the familiar restorative to health of the Indian banking industry is composed of "greater participation of the private sector in bank capital, a smaller footprint of the PSBs in the financial system, a cautious reduction in statutory liquidity requirements (SLRs) and assessing the effectiveness of directional lending would boost the system's capacity to support credit to the economy, while reducing moral hazard contingent fiscal liabilities". In fine, the multilateral bodies plead for striking the right and proper balance between maintaining social obligations and responding to market compulsions for addressing the systemic ills of the banking sector by the governing entity! IPA