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Event update: Financials; RBI stipulates 180 day resolution of bad loans – Negative for corporate banks

RBI has tightened the bad debt resolution framework further by withdrawing all existing schemes of debt resolution which gave forbearance to banks for as long as 18 months and replacing them with a single, stricter code. SDR/S4A/5:25 and restructuring all stand withdrawn as of 12th February and the JLF mechanism has also been dismantled. The new code is stricter than the old code because 1) it requires banks to first downgrade the loan to NPL and then implement resolution 2) It gives banks only 180 days to resolve stress failing which loans will have to be referred under the IBC. 3) The norms for upgrading loans have also been tightened. Loans can be upgraded only after 20% of principal / interest is repaid or one year whichever is later. Earlier upgrade was possible after one year of satisfactory performance.  4) Under the new code every resolution plan for loans of Rs1bn or above shall require independent credit evaluation (ICE) of the residual debt by credit rating agencies (CRAs) specifically authorised by the Reserve Bank for this purpose. While accounts with aggregate exposure of Rs5 billion and above shall require two such ICEs, others shall require one ICE. Only such resolution plans which receive an investment grade rating or better for the residual debt from one or two CRAs, as the case may be, shall be considered for implementation. Earlier there was no such requirement. 5) Every lending bank will have to participate in the joint resolution plan and cannot exercise its independent / bilateral restructuring with the borrower.

Most cases will have to be referred under the IBC: There has not been a single case where banks have been able to implement a resolution plan in 180 days which means that most of the new stress will have to be referred under the IBC. To start with RBI has asked banks to work on exposures of Rs20bn and above. For exposures below Rs20bn RBI will come up with separate time frames and reference dates. For loans above Rs20bn banks have to implement resolution plan within 180 days from the reference date of March 1, 2018 if the loans are already in default and within 180 days from the date of default if the default is after the reference date. If the resolution plan is not implemented in this time frame, banks will have to refer these loans under the bankruptcy code (IBC) within 15 days of the expiry of the term. This means that by September-end most of these loans will have to be referred under the IBC if not resolved. Whether resolved or referred under the IBC, banks will have to recognize these as NPLs first which will lead to higher NPLs and higher credit cost for FY19E. This is negative for all corporate banks. Whether the current infrastructure is adequate to admit so many cases under the IBC is a separate debate.

Prospective or retrospective – still a debate – but it is negative either ways: Banks say that it is prospective and does not apply to loans already restructured under existing schemes unless they become NPLs. We believe it is possible that the circular applies retrospectively because RBI has defined default in paragraph 2 of the circular as loans starting from SMA0, which is loans overdue between 0-30 days, and moving to SMA2 which is loans overdue from 60-90 days. RBI has not clarified whether the word default used in the context of resolution plan is 90 dpd or it is the definition used in paragraph 2 of the circular which defines default as SMA0-SMA2. A very high proportion of loans under the old RBI restructuring schemes would be in SMA0-SMA2 categories. So there is a possibility of the norms applying to at least 80-90% of the existing stock of SDR/S4A/525/std restructured loans depending on what RBI terms as default.  If the code is only for prospective stress, it is negative because going by the previous track record we do not see banks being able to resolve stress in 180 days. If it is retrospective it is draconian because in addition to new stress, most of the existing stress loans will also go the IBC way. If the code is only prospective, NPLs would rise by 100-120bps and credit cost by 15-18bps while if the code is retrospective, bad loans could rise by 4-7% across banks and credit cost would rise by 60-135bps. We will wait for clarification on this.

Stock specific: This is negative for all corporate banks. We prefer retail to corporate and within corporate we prefer private to state owned. HDFC Bank and IIB remain our top picks. ICICI Bank is our key pick among corporate banks. However, the new norms will impact ICICI too. These norms will be positive for ARCs and credit rating agencies.

What drove RBI to do this: Repeated divergences even after the AQR has probably prompted RBI to introduce theses tough guidelines so that banks do not evergreen and there is complete transparency in stress loan reporting. We believe RBI wants banks to move towards IND-AS provisioning by March 2019, at least on incremental loans even if IND-AS is not officially implemented. It also wants early resolution of stress rather than offering long dispensations which eventually lead to higher NPLs with a big lag. RBI has warned banks of penalties if these norms are violated.