Page 225 - ES 2020-21_Volume-1-2 [28-01-21]

208 Economic Survey 2020-21 Volume 1

7.4 The P. J. Nayak Committee (2014), constituted by RBI, highlighted in its report submitted
in May 2014 the twin concerns stemming from the forbearance regime: ever-greening of loans
by classifying NPAs as restructured assets and the resultant undercapitalization of banks. For
instance, it stated, “the existing tier-I capital for public sector banks is overstated because of the
regulatory forbearance which RBI provides on restructured assets. Without forbearance these
assets would be categorized as NPAs, the restructuring being a response to likely imminent
default. As a consequence, provisioning would rise, and tier-I capital would fall.” (pp. 27)
Thus, in essence, many banks were undercapitalized during the forbearance period. The report
had estimated that if regulatory forbearance were withdrawn immediately in May 2014 and a
prudent 70% provision cover were provided for restructured assets, tier-1 capital of the public
sector banks would be written down by INR 2.78 lakh crores. As we highlight later in Section
8.6-8.8, early resolutions of banking crises limit the damage from the same to the economy. Yet,
RBI dragged its feet in biting the bullet while attempting to persuade banks to recognize that
the distinction between NPAs and restructured assets is nothing but accounting sleight of hand
(Rajan, 2014 pp. 4). The consequent result was a further exacerbation of the situation.

7.5 Once the forbearance policy was discontinued in 2015, RBI conducted an Asset Quality
Review to know the exact amount of bad loans present in the banking system. As a result,
banks’ disclosed NPAs increased significantly from 2014-15 to 2015-16. In the absence of
forbearance, banks preferred disclosing NPAs to the restructuring of loans. Thus, the roots
of the present banking crisis go back to the prolonged forbearance policies followed between
2008 and 2015.

COST OF EXTENDED FORBEARANCE VERSUS EARLY
RESOLUTION OF BANKING CRISES: INTERNATIONAL EVIDENCE
7.6 The pattern of evolution of non-performing loans over time across G20 countries provides
valuable insights on the costs of extended forbearance versus early resolution of banking crises.
For this purpose, the year in which a country reached its peak NPA after the global financial
crisis is identified. The countries that reached their peak NPA during 2009 and 2010 (2009-2010)
are called “Early Resolvers”. These countries were likely early enough to recognize the bad loan
problem and take the necessary steps to address it. Their share of non-performing loans started
declining after 2009-10. These include countries like the United States, which immediately
recognized toxic assets and launched a recapitalization program.
7.7 In contrast, “Late Resolvers” correspond to the countries that reached their peak NPAs in
2015-19, i.e. up to a decade post the crisis. As shown in the case of India, where a prolonged
policy of regulatory forbearance allowed banks to delay recognition of actual NPAs, a delay in
taking actions to recognize and resolve bad loans may have caused the NPAs to culminate many
years after the crisis. Some important patterns between the “Early Resolvers” and the “Late
Resolvers” present interesting insights.
7.8 First, as seen in Table 2 and Figures 9-10, the “Late Resolvers” ended up with much higher
peak NPAs than the “Early Resolvers.” In fact, on average, NPAs for the late resolvers were
more than thrice that for the early resolvers (figure 11). Second, and more crucially, the impact
on GDP growth for the late resolvers (-1.7% on average) was significantly worse than that for
the early resolvers (-0.8% on average), as shown in Table 3.