Economy

RBI’s Monetary Policy

The RBI’s monetary policy Conundrum: It is no news that the central bank’s responsibilities pile up whenever a disaster struck a market. This scenario is especially true for pandemics like the covid. The problem of being economically destitute is something that the public in India and around the world is emphatically facing. With policy measures trying to restore normalcy in the market, consumer and producer confidence aren’t actively inspiring confidence in the economic recovery.

Not only has consumer confidence affected trade severely but also the crippled global supply chains are adding to the detestable attribute of the pandemic. This has led the RBI to maintain an accommodative stance in the economy, so as to infuse enough liquidity in the market.

This is being done to revamp the business and the financial sector of the economy. Since crippling lockdowns were placed in the economy, manufacturing and economic activity had contracted at an unprecedented level, so much so, that the economy had contracted by 23.4 percent in decades.

But such easy credit necessarily isn’t helping the economy. As a simple rule of economics, banks usually face two short-term tradeoffs. These are trade-offs between growth and inflation in the economy.

Given that the RBI has maintained an accommodative stance, supporting the growth for quite some time, inflation signs in the economy are starting to appear. These have been more persistent and significant in the consumer price index due to the burgeoning crude prices in the economy. Given, that OPEC has yet again decided to restrict the supply of crude, stating that demand is not robust, such woes are bound to be exacerbated.

RBI, in fact, has recently deciphered that inflation had hovered above its tolerance limit. The inflation of 6 percent was obliviously an uncomfortable range for the RBI given it tends to keep inflation in the 2-4 percent range (+- 2percent). Thus, the RBI now faces a conundrum, whether to prioritize the growth or inflation monitoring in the economy.

The Conundrum

The RBI right now faces a tough challenge between growth and inflation monitoring. This is due to the very crucial fact that the economic recovery is still in its nascent stage of recovery. The impetus or momentum that is needed to bring it on track can only be provided through excess liquidity in the economy.

As unemployment is on the rise, the manufacturing sector needs its engine oil to revamp in order to take on the world demand and to increase exports.

But, it is to be noted that this excess liquidity does not only pose a threat to inflation but also to bad debt in the economy. Given that the financial standing of many has been crippled by the pandemic, there are effectively high chances of default of repayment on loans. On the other hand, the USA is robustly considering and signaling toward the tightening of the monetary policy. This can lead to a taper tantrum and reversal of FDI in India. Thus, growth prospects can seem bleak for the country.

It is no news that when India had gone into lockdown back in the month of March last year, inflation was not even a blip on our anxiety radar. But in comparison to last year, today, the fiscal and monetary policymakers need to give serious attention to the concept of “stagflation”. This effectively means that the government will have to decipher early odious signs that signify any odd rise in prices amid economic stagnancy.

According to the reports, Retail inflation had effectively broken away from the Reserve Bank of India’s tolerance limit of 6% in the month of June. Consequently, it had risen to just above 6.73% for the month of July. But, for the month of August, it had taken a dip to 6.69%, which emphatically points towards its persistence in the economy. A closer look at the data shows that the immense contributor to inflation is the increasing food prices. Of these, protein-rich items are especially getting dearer.

Though to point down one reason is not feasible, it can be rightfully stated that an obvious culprit can be the snapped-off supplies. Though most of the restrictions have been eased, however not all supply chains have been fully restored.

Lastly, it is to be noted that as long as the inflation stays above the 6% mark, which marks the uncomfortable range for the RBI, it would face the policy conundrum and will be definitely wary of easing money any further. But if the rate cuts might actually stoke prices, so could a fiscal stimulus by the Central authorities, which can be a sagacious alternative. With the economy in a dire state of need of funds and state spending, the expansionary policy of the RBI is important.

Thus, this effectively means that the government will have to make important and crucial decisions now. An alternative could be that RBI can swerve to control the rupee’s internal rather than external value. With India largely acting open to capital flows, it can attract investments. Thus, what stance the Indian authorities will take will depend on what RBI perceives as a priority.

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Changes To ECB Policy

ECB Policy: Given the current market conditions in India, Indian corporations have had difficulty obtaining overseas finance. Credit from debt capital markets and onshore lending markets has been tough to come by given the current situation. The Securities and Exchange Board of India’s recent policies has effectively attempted to increase India’s debt capital market. This was also started in order to reduce corporate India’s reliance on loans from the Indian banking industry.

This is due to the fact that certain Indian corporations must absolutely, without exception, fund a specific percentage of their debt by effectively issuing bonds in order to obtain loans from the Indian banking sector.
The upcoming SEBI new standards for the Indian banking sector on single and group exposures have effectively driven some of the larger corporations to look at other choices. For satisfying their debt funding needs, these choices will look beyond their normal, conventional, favored relationship with onshore banks.

Significant sources of onshore debt in India, such as the mutual fund business and the non-banking sector, are apparently dealing with their own set of problems, which doesn’t help the situation. Given the current state of the onshore debt market, the proposed changes to the External Commercial Borrowing framework have been greeted with optimism.

The moves have been applauded since they will enable Indian enterprises to explore. This has also been done to ensure that Indian businesses are able to meet their financing requirements successfully.

This will go a long way toward easing the resolution of stressed assets in the Indian banking system, which is currently under strain. It should also be emphasized that the bad debt financing in India will ease off during the peak of the country’s crisis, with enormous potential to grow in the future. Due to the epidemic that has destroyed the financial situation of many people and businesses, numerous debt financing techniques and channels are required.

The Reserve Bank of India liberalized the framework that had previously governed ECBs in 2019. End-use restrictions were relaxed, and domestic lenders were allowed to transfer and assign their existing INR loans offshore.

What has changed with ECB revenues is that they can now be used to repay onshore INR loans and meet working capital requirements as needed. Non-banking financial companies that are registered with the RBI, on the other hand, will now be able to raise ECBs.

Companies in the infrastructure and manufacturing sectors, for example, can successfully raise ECBs to pay back INR loans. These can be used to fund INR targets that were obtained onshore and when the revenues of such loans were used to fund capital expenditure. Companies that are currently classed as SMA-2 or NPA (according to RBI rules) as a result of a settlement or agreement reached with the company’s lenders.

However, international branches and subsidiaries of Indian banks are not permitted to offer ECBs. The SEBI’s relaxations are expected to become more relevant for higher-rated Indian firms. Those who can get the best ratings. ECBs will be allowed to access offshore markets at a set price.

The RBI treats ECB funds that are utilized by borrowers in the infrastructure and manufacturing sectors to repay onshore loans, including stressed assets and NPA loans, more positively. Because the RBI’s latest move is designed to help resolve stressed assets. As a result, this is the most significant development in the Indian NPA market. This is because it allows Indian banks to sell nonperforming loans. The loans can be offered directly to ECB-approved offshore lenders.

Notably, this will very definitely lead to increased foreign direct engagement in the Indian distressed credit market. However, this is a major paradigm shift from the previous method. The current framework restricts investments to onshore vehicles and security receipts.

As a result, this innovative idea should enable onshore banks to allocate troubled loans to eligible offshore lenders. However, these foreign lenders should be immune from the RBI’s securitization rules. Resolving stressed assets in this creative way reduces the possibility of certain difficulties. Concerns emerge from the securitization procedure according to the RBI’s securitization requirements.

Notably, SEBI and RBI’s creative measures will allow troubled Indian firms to access foreign financial markets. To refinance their existing INR debt or to meet their specific working capital needs. The option will only be offered to higher-rated Indian firms. Using this approach, other Indian corporations will be able to receive considerable debt finance from the domestic debt markets.

The changes, on the other hand, are quite progressive, allowing direct assignment or transfer of current INR loans to foreign lenders. This will help to struggle Indian enterprises since it will help resolve stressed loan assets in India.

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Securitization of Financial Assets

With the burgeoning of globalization & liberalization, there has been a paradigmatic shift in the role of the banking and financial sector in monetized economies. There is an important reason to believe that a large number of non-performing assets in financial institutions is an important reason for the causation and deterioration of financial crisis. But is the NPA crisis an invincible enemy which cannot be mitigated? Thankfully, Asset securitization is the answer to the detestable NPA problem in the economy which can significantly help to bring the NPA crisis to its knees.

Asset securitization is considered an effective way to deal with NPA. The key issue in restricting securitization is the selection of NPA. It is to be noted, that many NPAs are significantly caused by a short-term cash flow shortage. But an opportunity can be presented to a bank if a significant quantity of funds can be committed to asset securitization which can emphatically have a good chance to covert NPAs into quality assets.

In financing terms, the advantages of asset securitization are tremendous. First and foremost, the financing costs are low. It is no news that disposing of NPAs requires huge cash flows, additionally, management of the same incurs humungous costs. Alternatively, in asset securitization, the user costs of the financing proceeds are relatively low. Compared to bank loans, relatively high-interest rates can be significantly avoided.

Additionally, compared to equity financing, the financing costs can be reduced while the enterprise’s organizational structure is maintained. Further, through asset securitization, the limit imposed by the credit rating of the NPAs themselves may be overcome through credit enhancement, to issue securities of a higher rating.

One of the biggest problems with lending out loans is the high risks associated with it. Consequently, NPAs too pose a huge risk to a banking structure. In contrast, an asset portfolio can reduce the risks of a single NPA. According to the investment portfolio theory, without reducing the anticipated return rates, combining negatively correlated securities can cause the risks of the securities portfolio to be less than the risks of any one type of security held.

As aforementioned, the credit rating of NPAs is relatively poor and the risks of default are quite high, but due to securitization, assets are of different risk levels which can be combined into an asset pool. Securitization allows different types of NPAs to enter one asset pool to achieve risk hedging; and, through accelerated transfer, separation, and centralized disposal of the NPAs by the capital market, the percentage of non-performing loans can be directly reduced.

Additionally, Risk remoteness emphatically eliminates the risks of the payment of the returns associated with the financed party. This leads to the major development in the design of an asset securitization structure i.e. establishment of a special purpose vehicle (SPV). This particular financed party removes the underlying assets from its hands by transferring the same to the SPV through a “genuine sale”. Subsequently, the SPV can use these as security to issue the securities. This emphatically helps in raising additional capital and a chance to gain profit through its gains.

Securitization, can additionally also allow the rapid removal of NPAs from the balance sheet. It allows quick sanitization of the on-balance-sheet assets and digestion of the accumulated risks from the sliding economy. This in turn leads to optimization of the asset-to-liability structure and strengthening of business operation capabilities, risk management capabilities, and core competitiveness.

Additionally, the market-based and mass disposal method has a scaling effect, reducing the economic and time costs of disposing of NPAs. As it is known, a huge percentage of NPA on the balance sheet of the bank speaks ill of its management and mitigation policy and in return hurts its credibility. Thus, asset securitization provides an ideal and profitable way of clearing the bad bank books.

NPA securitization can also increase an organization’s capital sources. Asset securitization can provide enterprises with a new means of financing. This effectively allows enterprises to break their current over-reliance on bank borrowing. Thus, Securitization effectively expands enterprises’ revenue sources. Through NPA securitization, an enterprise generally can revitalize existing funds, without in general increasing liabilities. Additionally, mitigating liabilities, it helps secure a low-cost fund source, increasing asset liquidity for a bank.

Is asset securitization a potent solution solely for the banking sector? Certainly not. Asset management companies too can profit from such lucrative ventures. Thus, specializing in the disposal of NPAs can present asset management companies with even greater opportunities.

Through NPA securitization, asset management companies can earn asset management fees, handling fees, and other such intermediary service fee income. This will deeply satisfy capital regulations and leverage the regulatory requirements of an asset management company.

Unlike in some countries where Assets Reconstruction Companies have been set up for the purpose of the bailout, in India, the Government has proactively initiated certain measures to control its burgeoning Non-Performing Assets crisis. In order to mitigate the Non-Performing Assets and quicken recovery, the Government of India in 1985 had set up SICA/BIFR, Debt Recovery Tribunals, and Debt Appellate Tribunals under the Recovery of Debts Due to Banks and Financial Institutions Act, 1993.

In an environment where market risks are relatively huge, currently, a pandemic struck the economy presents such a picture, that non-performing loan securitization products can provide new investment products for the capital markets.

In addition to capital markets, it emphatically can also provide products like open investment channels and increased product choice. While helping enterprises in effectively resolving non-performing loans, such products can satisfy different investors’ risk appetites and their ever-diversifying investment demands.

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Indian Authorities Failed to Make a Difference in NPA Crisis

The second wave of the COVID-19 pandemic ushered in an era of disintegrating companies, arduous acquisition battles, and heated arguments in courtrooms. While most companies struggled to stay afloat, those with deep pockets jumped onto the acquisition and organic growth bandwagon.

A giant that swore by this mindset was the Piramal Group whose resolution plan for Rs 37,250 for debt-ridden Dewan Housing Finance Limited (DHFL) received a conditional nod from the Nation Company Law Tribunal (NCLT), which subsequently received pompous and overwhelming approval from 94% creditors.  

Despite being one of India’s largest mortgage lenders, DHFL’s tainted history of unwise financial handlings led to it being the first financial services company to be notified for insolvency resolution under Section 227 of the Insolvency and Bankruptcy Code, 2016 by the Reserve Bank of India.

The case itself poses an exception, as the corporate insolvency resolution process under the Insolvency and Bankruptcy Code by the Reserve Bank of India is not applicable to financial service providers or banks. Therefore, the government’s action regarding the insolvency proceedings of financial service providers to enable the insolvency process of DHFL, which had defaulted on payment obligations, comes across as an exception to the Code.

The NPA crisis in India is an archaic evil eating into the mighty edifice of India’s banking sector. However, the government’s sheepishly reluctant attitude to deal with the burgeoning crisis is indeed one of the factors that have led to the digging of the grave of the mighty financial sector of India. Statistically, India’s bad debts amount to 11% of the total lending, whereas corporate bad debts constitute 56% of the total bad debts of nationalized banks. 

With another financial unit succumbing to the NPA crisis owing to governance concerns and payment defaults, India’s financial monitoring framework is ripe for reform and to nurse its post-pandemic financial system to health. The official perspective seems to maintain that the government looked after the vulnerable small and midsize firms during the pandemic.

This, according to the official authorities, has been done by guaranteeing fresh bank loans and mortgages under RBI. Consequently, this belligerent view has been supported by the low take-up rate for the RBI’s one-time restructuring offer. Given low consumer confidence and crippled economic growth due to partial lockdowns, the NPA crisis is doomed to materialize sooner or later.

According to the authorities, the NPA crisis can be dealt with later but what exactly is the question? Given, the DHFL’s insolvency, the financial system is doomed to fail given its failure to combat the NPA crisis. 

Papering over an economy-wide solvency problem by flooding the financial system with high liquidity is not only risky but also fatal for financial stability. It is to be noted, that the same strategy of incessant capitalization of the financial sector by the Indian authorities has time and again proved to be a concocted measure in vain, as NPAs of the financial sectors have never plummeted in recent history.

Even if they have, it is due to the practice of writing off loans from the accounting books in order to clean the financial records of the organization. But it is also something that the monetary authorities want to continue indefinitely which does little to help the bankrupt organizations. Alternatives, however, in the case of India are scarce.

This is due to the fact that India doesn’t have good tools to deal with insolvency. The 2016 bankruptcy law, had been reeling under the pressure even before the pandemic had struck. Liquidation, the outcome in most bankruptcy cases, has led to creditors recovering only 15%. This gross inefficiency can be scrutinized when compared with the global average of 80%.

Given all the detestable conditionalities against the government’s liquidity approach, the government extended the same regime to failing shadow banks. Dewan Housing Finance Corp., as aforementioned, is a mortgage lender whose controlling shareholders are currently in judicial custody on charges of accounting fraud and misappropriation of funds.

Talking about the archaic process adopted by the Indian authorities to settle DHFL, has left the suitors groaning about how shabbily the process was being run. With how the acrimonious contest shaped up, it’s certain that when the buyers control the reins, it will have to go through a lengthy legal challenge and will turn out expensive for creditors.

Clearly, due to all the aforementioned reasons, the task at hand is much more than filling the hole left by the $2.5 billion alleged fraud by Dewan’s former owners. With the government’s pro spending budget and increase in expenditure due to the vaccination campaign, bankruptcy in the financial sector is likely to wreak havoc on the monetary and political goals of the Indian authorities with the DHFL precedent.

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Humanising Debt Collections – A Fair Practices Code For ARCs

While the depiction of the Indian stressed asset market is often painted to look dismal, global globalization has put the screws on government and regulators to take decisive action. In a similar vein, India’s bad debt headache was alleviated with the inception of the SARFAESI Act, allowing banks to recover monies without judicial intervention. Despite that, the problem of mounting non-performing assets grew multi-fold thereby enhancing the prominence and aggression of Asset Reconstruction Companies (ARC) in financial circles.

Need for Fair Practice Codes

In wake of the mounting NPAs, the banking sector is under immense pressure to get its house in order. Realizing this, banks resorted to offloading bad debts from their loan books onto ARCs thereby leading to a massive reduction in their distressed assets. However, during this exercise banks made no provisions for these bad loans in their books, and bore no losses in case of defaults. This issue led to the intervention by RBI in form of the Fair Practice Code to ensure transparency in form of cash transactions.

Maintaining Transparency

Another reason for the need for the Code was that the sale of assets conducted by ARCs-in spirit-emerged to be no different from the sale of assets by state finance corporations or others vested with similar special powers of recovery. There have been many instances wherein ARCs sold assets through ‘private auctions’, and simply served a notice to the borrower. In this procedure, no account of the sale proceeds, description of the buyer or competing bidders, information on how the asset was sold, or expenses on the sale was provided to borrowers.

At this juncture, the RBIs notification will ensure transparent and non-discriminatory practices in terms of the acquisition of assets. To curb the issues and unclear process of assets being sold to bidders where there is no trace of information of who these individuals are, the invitation to participate in the auction will be made public.

This will also provide transparency in the way how many assets were being sold. The Boards involvement to make sure these rules are being held up is of utmost importance. When dealing with buyers Section 29A of the IBC must guide the process. The inclusion of Section 29A rendered persons contributing to defaults of the corporate debtor or other incapacities or are a related party, declares such parties as ineligible for submission of resolution plan and thereby preventing such persons from gaining control of the corporate debtor under the Code.

Simply put, the provision safeguards creditors of the company against unscrupulous persons whose aim is not a revival of the corporate debtor, but to reward themselves by undermining the objective of the Code. 

Thus, the notification aims to address issues of transparency and borrowers being kept in the dark during such sale of assets while keeping a check on the aggressive sale of assets by the banks and easy purchase by the ARCs. On contrarian grounds, FPC under the new regime would inadvertently restrict the enforcement action taken by ARCs.

Maintaining the spirits of Section 29A of the IBC or delving into investor control diminishes the powers conferred upon the ARC drastically. Moreover, it is pertinent to note that a regulatory directive from the central bank perhaps cannot have an overriding effect on legislations enacted to facilitate debt recovery, under the SARFAESI Act or the RDDB Act. 

Also, the sale of assets was not transparent and was far too commonly done at prices that do not represent fair values. Thus, these malpractices by the ARCs forced the RBI to come up with Fair Practice Codes to ensure transparency in transactions and keep a check on their practices. Under the notification, ARCs are entitled to release all securities on the repayment of dues.

If the right of set-off is exercised, then a notice to the buyer must be sent with information regarding the full particulars of the remaining claim and the conditions under which ARCs are entitled to retain the securities till the relevant claim is settled or paid.

Ethical Recovery Processes

Hereafter, ARCs must ensure adequate training to staff to deal with customer matters appropriately. This will prevent or mitigate unlawful and uncivilized harassment inflicted upon debtors in the name of debt recovery processes. In the spirit of this Code, ARCsmust establishes a code of conduct for Recovery Agents and also holds the company accountable in case of breaches by their Agents.

A compulsory set up of a proper Grievance Redressal within the company should be constituted by ARC. The officer’s name designated for that redressal must be mentioned during the process. Such machinery will prove to be a step towards settlement of issues subsisting between the ARCs and the borrowers or the banks.

In addition to this, initiatives to address the absence of a poor secondary market have been taken up. In the intention to outsource an activity, a suitable outsourcing policy needs to be established, a delegation of authority depending on risks and materiality, and systems to monitor and review the operations of these activities.

Conclusion 

Overall, the RBI’s guidelines reward assertive steps yet ethical recovery practices are strides in the right direction. This move will rationalize recent trends in the industry and prove advantageous to various stakeholders in the stressed asset sector, including defaulting borrowers. In light of the new guidelines, ARCs are likely to change their bidding strategy and cherry-pick deals backed by ‘hard’ assets reducing the number of deals.

At the heart of the ‘Fair Practices Code guidelines is the protection of debtors by humanizing the recovery process while striking an optimum balance between lender-borrower interests in the recovery framework. With an emphasis on compliances, transparent and non-discriminatory practices in the acquisition of assets, and the required release of securities upon repayment of dues, the FPC guidelines may collectively help insulate debtors from the clutches of the sale process.

Adherence to these guidelines will place these bad bank sponges on a game-changing pathway leading to reduced NPAs thereby reviving stressed assets in the banking sector and the Indian economy one step at a time, however not without some enforcement hiccups. 

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