By Dr K Srinivasa Rao
The recent roll-out of two sets of directions by the Reserve Bank of India, Transfer of Loan Exposures and Securitization of Standard Assets, are set to galvanise the credit flow in the financial sector, more so in the banking system. The new avenues permitting secondary sale of bank loans can potentially create buoyancy to accelerate the flow of fresh credit funded by proceeds of the sale of existing loans, including the non-performing assets (NPAs).
Permitting the sale of NPAs classified as fraudulent to asset reconstruction companies (ARCs) can be a game-changing move. Even if for some reason a loan is categorised as fraudulent, still it will have residual value as the whole of it may not be contaminated/unrecoverable.
The value realised from the fraudulent loan accounts can plough back into the bank’s lending resources. It can also trim asset size and improve the capital adequacy ratio of banks to that extent. The cumulative bank loans categorised as fraud stood at Rs 4.92 lakh crore as of March 31, 2021, working out close to 4.5% of the total bank credit. They cannot be kept unresolved perennially.
Helping the banking industry distil a good part of the loan book from the fraudulent stock of NPAs is essential to resolve such debts. Staff accountability and other attendant issues will, however, be as per laid down regulatory systemic controls.
Exposure Transfer Policy
Besides the loan policy, recovery policy, banks will have to now institutionalise their own internal transfer/acquisition of loan exposure policy to rebalance credit portfolio of different sectors by either putting to sale or acquiring loans from the secondary market. The standard norms of the RBI will help guide such policy. Stressed loans that are 60 days overdue but not yet classified as NPAs are also eligible for sale/acquisition collaborating with another bank/ARC. It will not only improve liquidity and risk management strategies but will also open up a new channel to rejig the mix of business, keeping the profitability and risk-adjusted returns at its epicentre.
In a growing economy, creation of an active tradable secondary market for bank loans is essential but the future experience will show as to how the new dispensation will shape up. Financial intermediaries should use this channel to manage their risks better. However, the dichotomy will continue where no bank would like to shed good loan accounts and no financial intermediary would ordinarily like to take on sour loans in a going business environment. Secondary trading will shift the exposure to better manage credit risk and avoid sector concentration.
Secondary Loan Market
There has never been a forceful effort to create a secondary market for bank loans so far that limits the risk management capability of banks. The most common risk is asset-liability mismatch. Banks borrow short and have to lend long in the given business model. Bank customers are increasingly preferring to place deposits for a shorter duration keeping their option of liquidity open to explore other investment opportunities whereas most of the lending has to be made for a longer duration. Even retail home loans have to be for more than 10 years.
The secondary market for bank loans now is mainly inter-bank transactions, undertaken on an ad hoc basis from one bank to another, and sale of stressed assets by banks to ARCs. While banks have been successful in transferring a chunk of the stressed loan portfolio to ARCs in recent years, the inter-bank transactions of loan accounts have been relatively infrequent. The other chunk of inter-bank movement of loans takes place at the behest of the borrower, mostly coming from the interest rate differential. Even ARCs are not doing impressive work in realising the value of underlying assets against the acquired stock of NPAs.
In August 2021, ten major lenders, including State Bank of India, ICICI Bank, Canara Bank and Standard Chartered Bank, for the first time joined hands to set up an online platform for trading of corporate loans in the secondary market. Called the Secondary Loan Market Association (SLMA), it has been formed on the recommendation of the RBI’s Task Force on the Development of Secondary Market for Corporate Loans. It will provide an opportunity even for mid-size and smaller banks to participate in large creditworthy lending exposures that they could not originate.
Banks will be better able to comply with the ‘large exposure framework’ of the RBI and match their credit risk to their risk appetite. Going forward, SLMA will be standardising and simplifying primary loan documentation and enable other mechanisms to activate secondary loan markets. Eventually, it will set rules for members, promote standard trading norms, timelines, streamline settlement, valuation procedures and bring global best practices to the online mechanism. Standardisation of transaction charges and related norms will evolve as activities gain traction.
Freeing liquidity for fresh loans
Adding on to the SLMA resolution, the new RBI guidance should pave the way for mindset change of both financial intermediaries and borrowers. Both need not get stuck with one entity. Along with a policy, banks will have to set up a separate division to deal with the transfer of loan exposure with a state-of-the-art market intelligence system to avail first-mover advantage. Sell quick and buy quick to create value for the organisation. If the backend processes are intact and the follow-up mechanism is good, even stressed assets will be realising the value through the use of the Swiss Challenge method (SCM) to discover competitive pricing of assets.
SCM method entails calling for a quote for a loan asset and then using it as a base price, open it for further auction to discover optimum price. The SCM is mandatory to be used for assets of Rs 100 crore and above. The secondary sale of loans will prompt borrowers to maintain a good credit rating and ensure better value for underlying securities/onsite property. The new move can potentially enable banks to mitigate risk and use freed resources from the secondary sale to fund fresh loans.
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