Kamath formula unlikely to alleviate stress in banking or revive growth

On September 7 the Reserve Bank of India (RBI) accepted a report submitted by a five-member committee headed by K.V. Kamath, the former CEO of ICICI Bank, entrusted with the task of defining parameters and rules that would determine how pandemic-hit borrowers would be allowed to “restructure” stressed loans drawn from the banking sector.

However, although the committee submitted its report to the RBI in double-quick time, within a month after it was constituted by the central bank, it is unlikely to provide a pathway to relief for borrowers whose operations have been gutted in the pandemic. Nor is it likely to goad risk-averse bankers to lend a helping hand to guide borrowers to safety.

The starting point of the committee’s report are two critical observations, both of which have had a bearing on its prescriptions.

The first is the stipulation that only loans that became “stressed” after  March 2020 would be considered for restructuring. Given that large sections of the Indian economy – automobiles, for instance — were in a crisis well before the pandemic hit India, this attempt to sterilise the “Covid effect” from other factors appears a facile one.

The second observation is a trite one, that almost three fourth of the loans extended by the banking sector are in the “stressed” zone.

Both points, however, reinforce the perception that the committee and the Central Bank appear to hold a remarkably close approach to the one adopted by the Union Finance Ministry under the leadership of Nirmala Sitharaman ever since the pandemic hit Indian shores with force in March.

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One of the stand-out features of her stewardship has been the niggardly approach to provide relief to swathes of the economy that have been laid low in the wake of the pandemic. Effectively the uniquely Indian approach has been to hope for the banks to step in without the Finance Ministry actually putting money where its mouth is.

The Kamath panel has gone about its business like a diligent schoolboy. It provides a long list of 26 sectors/industries, which practically covers every aspect of the economy, barring agriculture.

In particular, the pandemic has hit hardest activities such as retail and wholesale trade, roads, textiles, and engineering. Sectors that were already under stress before the pandemic, such as non-banking financial companies (NBFC), power, steel, and real estate, have gone into a deeper crisis in Covid’s wake.

The diligent schoolboy’s hand is again on display in the manner in which it advocates the use of five financial ratios to determine a particular sector’s eligibility for relief.

The ratios, which measure borrowers’ ability to repay, are sector-specific. For instance, debt as a proportion of a company’s EBIDTA, the portion of a company’s overall earnings before factoring in outgo towards interest, taxes, depreciation and amortisation, indicates whether the entity’s level of debt is viable.

Strikingly, the real estate sector has been provided greater leeway — significantly, within it, the commercial real estate segment has been favoured even more. The committee advocates that real estate housing projects be allowed a Debt/EBITDA ratio of 9; the commercial real estate has been given a wider berth of 12.

In contrast, iron and steel manufacturing has been prescribed to have a maximum debt/EBITDA ratio of 5.5 and logistics a limit of 5. Why the ratio is different for different sectors, or, on what basis these have been arrived at, are not explained anywhere in the committee’s brief 16-page report. Based on the application of these five ratios the committee asks bankers to classify stressed loans into “mild”, “moderate” and “severe”.

The most striking feature of the report — bearing remarkable coincidence to the approach of the Finance Ministry’s and the RBI’s fond hope that liquidity infusion will do the trick for the revival of the economy — is its failure to provide a systemic assessment of how Covid has wiped out large swathes of productive activity in India.

This obvious prerequisite for charting a course to recovery leaves tremendous leeway to the banking industry to what is essentially the task of the central bank and the government, acting through its Finance Ministry.

The committee has fulfilled its formal task of setting out criteria that banks should adopt while providing relief.

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In effect, it has thrown the rule book at the banks, leaving it to them to decide what activity, which sector or which client is worthy of support.

Again, in keeping with its technical approach that avoids a systemic assessment, rather arbitrarily, it has set a deadline of March 22 by when “restructured” loans meet specified financial targets.

The Resolution Plan, which would be applicable to loans that are restructured provide for an Inter Creditor Agreement that would enable all lenders to the concerned entity come together in coordination. Significantly, the report advocates that the restructuring process to include the possibility of change of ownership of “stressed” accounts or for the conversion of debt into equity.

In effect, the Kamath committee provides much more than a rule book. It pushes banks to see the pandemic as a business opportunity. Seen from this perspective, it appears to rely on that old cliche: every crisis is also an opportunity, for some at the cost of the many.

The lack of a systemic approach to the unprecedented crisis is unlikely to help industries to get back on their feet. The failure to assess industries in terms of the ecosystem in which they operate is reflected in the Kamath panel’s failure to integrate the fragility of MSMEs into the rule book not has devised. This is no small matter.

Large sections of Indian industry — automobiles and textiles, for instance, come readily to mind, but there are many more — have integrated MSMEs into their production process in the last few decades.

Banking industry sources have already pointed out that loans of about Rs. 5 lakh crore may need to be recast. But, even this is just the tip of the proverbial iceberg. As time goes by, with industry remaining mired in contraction, these will only increase.

So far, the Narendra Modi’s approach has been to leave the problem to the banking industry to resolve, regarding this as a purely commercial proposition.

The recent release of GDP data, revealing the sharpest contraction of output among the economies of the world, has obviously failed to serve as a wakeup call.

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Rating agencies, brokerage houses and analysts are busy revising downward the projections for Indian economy in the current year. Fitch has revised its rating for 2020-21 from the earlier projection of -5 per cent to -10.5 per cent.

The  Kamath panel’s report is of a piece with the mandarins at North Block and those at the helm of the RBI. Perhaps it may have been a mistake to have expected more from it, but all in all, the grim tidings continue to flow in a flood as the pandemic sets new highs.