Rajan shielded Indian banks from a Lehman-like crisis. And how!

Ever since Raghuram Rajan took charge as the 23rd governor of the Reserve Bank of India in August 2013, the central bank, in tandem with the government, has introduced a series of reforms and measures in the banking system to support growth and bring down non-performing asset. 

But has RBI really done enough to pre-empt a possible collapse of the Indian banking system, far less to avoid a Lehman-like crisis in India? 

The collapse of the global investment bank, Lehman Brothers, in September 2008 had brought the financial sector the world over to its knees. With $639 billion in assets and $619 billion in debt, Lehman's bankruptcy filing was the largest in history. 

Even though the economic recovery is not happening at the desired pace, RBI and the bank boards have made it reasonably clear that they would not let a Lehman moment occur in India," Saurabh Mukherjea, CEO Institutional Equities, Ambit Capital, said in an interview with ET Now. 

Raghuram Rajan specifically said two weeks back on the sidelines of the money policy meet that he would make sure that India does not have its own Lehman Brothers moment. 

"The banking system is not going to the dog house and that is why I took the crisis call off the table. So, assuming a modest scenario of around 10 per cent earnings growth this financial year, it will lead Sensex to around 29,000-29,500 in FY17," he added. 

So what steps have RBI and the government really taken to support the banking system and reduce stress on assets in the banking system? 

Asset quality review: The asset quality review (AQR), which was started by the Reserve Bank of India (RBI) back in February this year, was to ensure banks were taking proactive steps to clean up their balance sheets, which will help them in the long run. 

Under the scheme, banks have been advised to clean up their balance sheets and declare certain accounts as non-performing assets (NPAs), which are at present not marked as such. 

Following the asset quality review, banks have reported a near 70 per cent surge in non-performing assets over the past six months. 

Gross NPAs of banks and institutions have shot up by Rs 2,41,000 crore in December and March quarters, mostly due to aggressive provisioning undertaken by the PSU banks at the behest of RBI. 

Indradhanush: A ray of hope for PSU banks 

The acceleration in recognition and provisioning for non-performing assets (NPAs) is only an initial step in the revamp of Indian banking. 

The Centre is looking to inject some life into the public sector banks (PSBs) with the launch of a seven-pronged plan - Indradhanush - on August 2015 to infuse Rs 70000 crore. 

The Indradhanush plan is already in works with an allocation of Rs 250 billion in the Union budget for 2016-17 for capital infusion into PSBs. While this allocation is largely being seen as insufficient, the government emphasised that it would not be considered the last word with respect to recapitalisation of PSBs and that the government is committed to providing more capital. 

PSBs should raise the remaining Rs 1,10,000 crore from the market. Moreover, the government is committed to making extra-budgetary provisions in FY18 and FY19 to ensure that the PSBs remain adequately capitalised to support economic growth. 

Bankruptcy code - A step in right direction 

The government gave a nod to the new bankruptcy code in May 2016. The bankruptcy bill will make it easier to exit or attempt a revival of business and will help speedy winding up of insolvent companies. 

"The new law will provide for dealing with bankruptcies, replacing multiple laws dealing with the issue, including the Companies Act, 2013. This will also help drastically in containing the non performing loans in the financial sector," The Institute of Company Secretaries of India said in a report. 

The law will ensure time-bound settlement of insolvency, enable faster turnaround of businesses and create a data base of serial defaulters-all critical in resolving India's bad debt problem, which has crippled bank lending. 

"Apart from this, foreign lenders will also be more comfortable in extending loans, which are a plus for the country. The new law is expected to improve India's ranking in the World Bank's index of ease of doing business," the report said. 

Sustainable structuring of stressed assets: The Reserve Bank of India's scheme for sustainable structuring of stressed assets (S4A) is yet another tool provided to the banks to tackle the growing challenge of stressed assets emanating from loans given to large companies turning bad. 

Experts say this is an improvisation of the two other tools announced by the regulator in the past 18 months to address asset quality challenges at banks: structuring of project loans under the 5:25 scheme, and strategic debt restructuring (SDR). 

CrisilBSE -0.79 % estimates that weak assets in the Indian banking system will touch a high of Rs 8 lakh crore by the end of this financial year. 

S4A could help banks limit fresh slippages to non-performing assets (NPAs) from large corporate exposures. "S4A envisages the determination of a sustainable debt level for stressed borrowers, and bifurcation of outstanding debt into sustainable debt and equity/quasi-equity instruments, which are expected to provide upside to lenders when the borrower turns around," said the Crisil report. 

MCLR - Enabling faster policy transmission: The Reserve bank of India (RBI) slashed rates by 150 basis points (bps) since the start of last year, but the country's banks have cut lending rates by less than half that. The repo rate stands at a five-year low of 6.50 per cent. Enabling faster transmission would help credit growth in last 4-8 quarters. 

The banks have reduced their lending rates between 0.6% to 0.8% only. The changes in repo rates did not directly affect their lending rates, leading to a mismatch in the transmission of these reductions to banks' customers. 

In order to deal with the mismatch and bring parity between lending rates, the RBI mandated banks to adopt the marginal cost of funds based lending rate (MCLR) method .

The MCLR considers the marginal cost of funds, which is based on the cost of funds due to the interest payable on its deposits as well as the repo rate, cost of maintaining CRR, operating costs & a tenor premium. The final rate for a borrower will be calculated after adding the credit risk premium to the MCLR.