Page 217 - ES 2020-21_Volume-1-2 [28-01-21]

200 Economic Survey 2020-21 Volume 1

The prolonged forbearance policies following the GFC thus engendered the recent
banking crisis that brought down investment rates and thereby economic growth in the
country. The first lesson for policymakers is to treat emergency measures as such and
not to extend them even after recovery: when an emergency medicine becomes a staple
diet, it can be counterproductive. Second, while the learnings from the previous episode
must be employed to avoid a recurrence, ex-post analysis of complex phenomena must
be disciplined by the insights highlighted in Chapter 7 of the Survey. Specifically, to
enable policymaking that involves an exercise of judgement amidst uncertainty, ex-post
inquests must recognise the role of hindsight bias and not make the mistake of equating
unfavourable outcomes to either bad judgement, or worse, malafide intent.

INTRODUCTION

7.1 To address the economic challenges posed by the Covid-19 pandemic, financial regulators
across the world have adopted regulatory forbearance. India is no exception. Emergency
measures such as forbearance prevent spillover of the failures in the financial sector to the real
sector, thereby avoiding a deepening of the crisis. Therefore, as emergency medicine, forbearance
occupies a legitimate place in a policy maker’s toolkit; see Box 1 for an explanation of the
economic rationale for forbearance. However, caution must be exercised so that emergency
medicine does not become a staple diet because borrowers and banks can easily get addicted to
such palliatives. When emergency medicine becomes a staple diet, the negative side effects may
not only be large but may also last for a while. Therefore, carefully examining and understanding
the implications of previous forbearance episodes is relevant to guide future policy. In 2008,
anticipating the global financial crisis, RBI introduced the policy of regulatory forbearance. It
relaxed the norms for restructuring stressed assets - downgrading the asset to non-performing
status was no longer mandatory and required no additional provisioning; see Box 2 for the
description and timeline of the same. This chapter studies the impact of the 2008 forbearance
policy on banks, firms, and the economy in general to glean important lessons for the current
times. As Spanish philosopher George Santayana cautioned, “Those who do not learn from
history are condemned to repeat it.”

Box 1: Economic Rationale for Forbearance

The following illustration describes banks’ choices while dealing with a stressed asset with
and without forbearance. In this context, we must keep in mind that when a bank creates
additional provisions to account for loan losses, the bank’s profits decline and thereby lead to
a reduction in the bank’s equity capital. Therefore, the incentives to provision for bad loans
gets significantly impacted by regulatory forbearance.

Without Forbearance With Forbearance
1. If the project is viable, the bank would 1. If the project is viable, the bank would
restructure the asset and downgrade it restructure the asset. As restructured
to a Non-Performing Asset (NPA) and assets do not require the same level
provision for the same. of provisioning as NPAs, inadequate
provisions are made.