Let’s step back from the NPA Scare

Synopsis: Lenders must be less afraid of regulators and agencies so that they can aggressively restructure debts. 

Introduction  

In India, there is a “NPA Scare”: An inflated fear of NPAs and lender losses. Failure of a business and credit losses are unavoidable in lending. We will hinder economic growth if we avoid all NPAs or demonise default. The emphasis on human interest tales and failed transactions tends to hide the large amount of successful lending that occurs. 

• The three things that are wrong with the Indian credit market: Banking regulation, the lack of a capable bond market, and bankruptcy reform. 
• Default-free lending: buy AAA-rated 90-day government bonds from the United States or Germany. These produce a yield of about 0%. Purchasing an Indian government bond demonstrates a willingness to take risks. 
• If policymakers or board members seek exceptionally low nonperforming assets (NPAs), sensible financial plans and loan access are hampered. It’s similar to selling life insurance and expecting clients to not die. Business failure is a part of life, so credit defaults will always happen. 
• Currently, financial authorities and agencies are vigilant in preventing future defaults and pursuing past defaulters. As a result of the NPA scare, businesses are reducing their borrowing. They are using more equity capital and are investing less, which is hurting GDP growth. 
• Deaths faced by life insurance companies surge in a pandemic. Business failures rise when growth declines. When Indian growth slowed in the last decade, defaults increased. This is the normal working of the market economy. 
• A huge volume of debt transactions goes through successfully all the time. As financial economist Harsh Vardhan told that about 12 trillion of new credit takes place every year. But a few big defaults are highlighted which fuels the NPA Scare.  

What are the problems in the Indian credit market that require solving? 

There are three problems in the Indian credit market that require solving: Banking regulation, bond market, and bankruptcy process. 

• Firstly, the weaknesses of banking regulation. In India, banks have provided loans, had defaults, and then gone bankrupt after the defaults were paid. The NPA scare should not be fuelled by bank fragility; rather, it should serve as a catalyst for improvements in banking regulation that would fix the problem. 
• Secondly, non-implementation of market-based accounting. The job of banking regulation is to force market-based accounting upon lenders, this has not been implemented. Banks have overvalued their portfolios and regulators have supported this. Regulators must force banks to assess the market value of loans and mark their portfolios to market every quarter.  
• Thirdly, the problem is the bond market. Banks have short-dated deposits and are structurally unable to do long-term lending. There are structural failures in financial regulation which have held back the emergence of the bond market.  

• The losses should not add to the NPA Fear; instead, they should prompt the necessary bond market changes. This is a work programme that was started in the 2015 Finance Bill but was cancelled. 

• Fourthly, the bankruptcy code is about reducing the losses suffered by lenders when default takes place. The bankruptcy process must begin, with the committee of creditors taking over and finding a value-maximizing agreement for lenders. The bankruptcy code should make it more difficult for promoters to hide their theft, resulting in retaliatory actions. 

The way forward 

• Regulators and agencies need to instil less fear in lenders, so that they are able to restructure debts when faced with early signs of distress. A small loss in restructuring is generally better than a large loss in bankruptcy.  

• The Indian bankruptcy reform has been in play since 2016, but the elements described here have not fallen into place through the combination of regulators, courts, departments, and agencies. 

 The problems of the bankruptcy process should not fuel the NPA Scare; they should generate the energy to come back into the bankruptcy reform with fresh energy and intellectual capacity. 

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