The financial sector is one of the most powerful and important institutions that helps in aiding the economic development of any country and having a multiplier effect on the pace of economic growth. Accordingly, it is inevitable for an economy to have transparent and credible systems, governance framework and procedures in place in order to maximise the positive impact of the financial sector in the overall economic development.
With regards to the Indian financial sector, amongst others, ever-greening of stressed loans, round-tripping of loans are some common malpractices that resulted in banks and corporates concealing bad performance and depriving the relevant stakeholders including the public from having access to true and fair view of their state of affairs thereby resulting in the bourses also not reflecting the appropriate price of relevant securities.
One of the biggest evils plaguing the Indian financial system for quite some time is the under-recognition and inadequate reporting of bad loans or non-performing assets (NPA). The RBI had in the year 2015, as part of its fourth bi-monthly monetary policy statement for 2015-16, reported that there have been instances of divergences as regards asset classification and provisioning by banks vis-à-vis the prudential norms on income recognition, asset classification and provisioning. In order to curb this menace and bring in greater transparency and better discipline, disclosures in the notes to accounts to the annual financial statements (published immediately following communication of such divergence by RBI to the relevant bank) was introduced by the RBI in 2017 where such divergences exceeded specified thresholds. There was a dire need for the introduction of such a norm since RBI noticed that the actual information on asset classification and provisioning released by banks to the public were 'materially' different from RBI's findings and did not reflect a true and fair position. The capital markets regulator, SEBI also came up with a direction in 2017 itself for similar disclosure requirements for all banks having listed specified securities. Post implementation of this disclosure requirement, many banks came under excessive public scrutiny since there were astronomical differences between the recognition of asset classification and provisioning by banks and RBI's findings.
In respect of reporting of NPA divergences, the RBI had in April 2019 clarified that the intention was to have only 'material' divergences disclosed and therefore it tweaked the relevant thresholds for reporting of such NPA divergences. The SEBI was also quick to acknowledge such revised framework for reporting of NPA divergences by banks having listed specified securities. The SEBI, in consultation with the RBI, has very recently further tightened the NPA divergence reporting framework on the understanding that NPA divergences beyond prescribed thresholds is 'material' and 'price-sensitive' information. Accordingly, in accordance with the SEBI regulations, the revised framework requires such disclosures with respect to NPA divergences to be made promptly upon receipt of final report on NPA divergences from the RBI rather than waiting to publish them as part of annual financial statements. This regulatory directive also destroys the impasse over how and at what stage such NPA divergences should be reported and will avoid any disclosure irregularities by listed banks as was experienced in the very recent case of on the largest private sector lender, Yes Bank which earlier this year made a prompt 'selective disclosure' to the stock exchanges that RBI did not find any divergences for FY 2017-18. This not only led to lender earning RBI's ire but also warranted Yes Bank and its compliance officer to settle the matter with SEBI.
By way of a separate direction issued in November 2019 to all private sector banks and foreign banks operating in India, the RBI has, in order to further tighten the noose on the issue of divergences, amended the guidelines on compensation of key officers of such financial institutions. As per the recently issued instructions, the RBI has advised that in case the assessed divergence in bank's provisioning for NPA or asset classification exceeds prescribed thresholds, as regards such key officers, any unvested portion of variable compensation would not be payable and no proposal for increase in variable pay would be permitted for the relevant assessment year.
In another important move, the capital market regulator has in November 219 made it mandatory for listed companies to disclose, within a day, details of defaults on payment of interest / repayment of principal amount on loans, including revolving facilities like cash credit, from banks / financial institutions which continue beyond 30 days from the pre-agreed payment date. Additionally, a quarterly disclosure in this regard has also been mandated for the listed entities. While the disclosures, including quarterly disclosures, are required to be made beginning January 2020, this information being in public domain will act as a catalyst along with the other bad loan 'clean-up' measures taken and would usher in an era of transparency and credit discipline and also assist the credit rating agencies in their assessments. This should go a long way in keeping the relevant stakeholders informed about the financial well-being of the relevant listed entity and putting a check on how lenders deal with stressed assets thus preventing ever-greening of loans and helping narrow the reporting of divergences by lenders.
A similar direction to report loan defaults was earlier issued by SEBI in August 2017 asking all listed companies to disclose any loan defaults within 24 hours of the event. While such disclosure norms were to be made effective from October 1, 2017, opposition from some quarters had led to withdrawal of the same merely a couple of days before such date. Given the state of the economy, this year should see the much-needed progression in the clean-up exercise. This much awaited regulatory decision will raise timely red flags putting pressure on the listed borrowers to address the situation. While this direction has been issued with the right intent, in order to make it more effective, the government may also consider expanding the scope of this disclosure requirement to also mandate listed entities to make such disclosures in case of loan defaults by their unlisted subsidiaries and, in any case, in respect of their material unlisted subsidiaries.
While a number of important reforms are being introduced, for the Indian economy to have a much more transparent and world class financing system and the much needed credit stability, in addition to the steps being taken with respect to clean-up, governance standards and more stable and prudent reporting standards for banks, it would not be out of context to expect, as a matter of priority, bringing about changes in the functioning and cleaning-up of non-banking finance companies space, as it already forms a significant part of the Indian financial system and plays a crucial role in the overall credit and economic growth.
Given the recent initiatives / actions taken, it is very clear that the importance of a well-regulated and fundamentally strong financial sector to the Indian economy has been very well understood and steps are being taken in the right direction to bring about structural changes with respect to the functioning and bringing about high level of transparency in the Indian financial sector and removal of unsound practices. Introduction of the new insolvency and bankruptcy law (and recent amendments to the same), demonetisation, stricter disclosure norms and enhanced governance standards are some of the key steps taken in the recent past. While there may be short term pain in the system owing to further clean-up due to the recently introduced framework, the same should certainly help in reducing the toxicity in the corporate culture and give a big boost to investor sentiment and would go a long way in achieving the government's ambitious target of making India an USD 5-trillion economy and a much more stable investor friendly destination.
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