Insolvency proceedings credit positive

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Moody’s says banks profitability may be affected over a year if they take large write-downs

Credit rating agency Moody's Investors Service India on Monday said the RBI-initiated insolvency proceedings against 12 large loan defaulters is credit positive for Indian banks as it will eventually improve their asset quality.

The Reserve Bank last Wednesday said it has identified 12 large loan defaulters, which account for 25 per cent of the total non-performing assets, or bad loans, in the banking sector and will be referred to the banks concerned for filing insolvency proceedings under the Insolvency and Bankruptcy Code, 2016 (IBC).

These cases will be accorded priority by the National Company Law Tribunal (NCLT).

"This is credit positive for India's banks because any meaningful resolution under this plan can help improve their overall asset quality. Additionally, it also will set a precedent for resolving non-performing loans from smaller borrowers," Moody's said in a report authored by Alka Anbarasu, vice-president and senior analyst.

The directive will negatively affect banks' profitability over the next year if they need to take large write-downs relative to their existing loan-loss reserves for those assets, it said.

"This also will accentuate the capital needs of weaker public sector banks, which may require a large capital infusion from the Indian government," it said.

Moody's estimated that state-owned banks will need up to Rs 95,000 crore of equity capital through 2019, vastly more than what is estimated by the government.

The capital requirement is much higher than Rs 20,000 crore budgeted by the government towards capital infusion until March 2019. Under the Indradhanush plan for bank recapitalisation, the government is infusing Rs 70,000 crore in PSU banks, beginning 2015.

RBI has also asked banks to review other NPAs and finalise a resolution plan over the next six months.

"Given the strict timelines to resolve a case under the IBC within a maximum period of 270 days, after which a company will be automatically liquidated, we expect that this directive will significantly expedite the resolution process and will help in loan recoveries," Moody's said.

The credit rating agency estimates that some of these 12 accounts relate to borrowers in the steel, power and other infrastructure sectors such as engineering, procurement and construction contractors.

"Indian banks' asset quality has significantly deteriorated over the years, although the pace of deterioration has somewhat moderated in recent quarters. In addition, despite multiple measures from the RBI and the government, banks have had limited success in resolving stressed assets given an overall weak operating environment and the limited capacity of many banks to absorb losses from a write-down that may need to be taken for a resolution,” Moody’s said.

“We also expect that the effectiveness of resolutions under the IBC will be limited. In particular, once a resolution under the IBC is initiated, control of the company shifts from existing management to insolvency professionals. Nevertheless, given the nature of the assets, we expect that the management team in some cases will continue to play a role in preserving day-to-day operations. In addition, the strict timelines of a resolution may force some companies into liquidation and may have a negative effect on banks, particularly in cases where little collateral is available,” the Indian arm of the global credit rating agency said.

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