Preventing the pile up of NPAs-II

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Preventing the pile up of NPAs-II

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• Giving up core responsbility: Many banks have now started outsourcing their credit monitoring work via CMAs (Credit Monitoring Agencies), to address NPA related problems. There are checklists (upto 63 items) provided by banks, and perhaps compliance is reduced to checking the boxes. Noise and signals will get mixed. This is not possible when banks outsources such tasks.
• Solution: The Rs.250 cr threshold for outsourcing it may be brought dow to Rs.100 cr, to cut frauds and NPAs. 
• Catching signals early: In 2002, the RBI introduced the Special Mention Accounts (SMA) to find new stress. But NPAs could not be tackled by it. Why? Signals were not aligned with monitoring tools, and a deeper root cause analysis is now needed.
• When to give regulatory forbearance: Firms may face stress due to cyclical or secular reasons, and both aren't the same. If steel prices crashed to $ 300 per tonne by 2012, from $ 1000 per tonne, and many units went bankrupt and were sold off in the IBC with major haircuts. Then, steel rose again to $ 1000 per tonne! This is a "cyclical decline".
• Power sector: Many producers went into the red, as power prices crashed, never to recover, and with the RE revolution, most fossil-fuel based producers have a dark future. That's a "secular decline" and banks lost their shirt. 
• Some solutions: Reduce the time gap between idea and implementation in the "Risk Based Supervisor" system of RBI. Exchange of officers with banks can help RBI learn better. Even the specialised branches set up by banks (for corporate or industrial finance) did not help, and turned NPA centres.
• RBI's 2021 measures: It recommended - (i) enhanced role for independent Directors, (ii) manner of appointment, reconstitution and chairing of committees, (iii) meeting frequency, (iv) no conflict of interests, (v) related party transactions' scrutiny, etc. Sadly, many non-executive chairman positions (and directors' too) are vacant for long. So effective implementation isn't happening, something the BBB has to now ensure. [BBB - Banking Boards Bureau]
• Thirty risks listed: New Governance advisory has a list of 30 risks but actually just one risk - Conduct Risk - overshadows all others. Proof is the recent major failures at some large NBFCs and big banks. Clearly, Boards have failed in their basic duty, given the NPA pileups.
• What is DFS doing: The Department of Financial Services (Finance Ministry) oversees the working of various govt.-owned FIs. But the "arm's length" relationship is hardly maintained, as the DFS issues borrower specific advisories too (formal, informal). If this distance cannot be maintained, do not blame the PSBs.
• Infra finance and DFI: It was good that the govt. finally set up the Development Finance Institution (DFI) in April 2021, but we need more than one. Project finance is risky business (as commercial banks learnt), and only few big banks may be allowed now. 
• Final summary: The road ahead cannot be the same as it was earlier, for lenders, govt. and supervisors.

1. Banks have to redo the entire credit appraisal process, using the CCC formula (Character, Capacity, Capital)
2. Excesses in lending must be identified quickly and exuberant lending moderated
3. Separate forbearance given for cyclical from that in secular declines of industries
4. Boards' role must be strengthened
5. Government must stop giving customer specific advisories, and focus on broad policy only.

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