The demonetisation of currencies in India has led to a debate as to whether the option of tackling the Non performing assets of the financial institutions would have been a better option and causing lesser inconvenience to the public at large. The point is well taken that this is also an issue to be addressed.
The issue, however, many are not aware of the intricacies of the classification norms of the Reserve Bank of India or its intent. The Reserve Bank being a regulatory body desires to ensure that at no point liquidity is in a crisis resulting in a run on any bank or financial institution. In this direction it prescribes cash reserve ration and statutory liquidity ratios to be maintained. In fact, the SBI is on record stating that the biggest non performing asset is the amount parked as cash reserve ratio as it does not earn any returns. Further, to ensure a strict vigil on the borrowers, it terms any borrowing which has even a small default of either repayment of principal or interest either in full or part for a period of 90 days or more to be classified as a non performing asset. The non performing assets are itself classified as sub standard assets, loss assets and doubtful assets. Besides this the institutions are also to classify the rest of them as standard assets. The mere classification does not have any bearing either on its realization or the borrowing turning bad warranting a write off.
The Reserve Bank recognizes this aspect and only requires a portion of the unsecured exposure to be provisioned for the purposes of non performing assets. Thus, if one were to consider a loan of Rs 1 crore lent by the bank with a security of an immovable property worth Rs 3 crores, there would be no real reason for provisioning against the asset in case of a couple of defaults as the unsecured portion would still be nil. It is only when the unpaid interest component reaches Rs 2 crores or is nearing it that provisioning needs to be made.
It is taking into account this cushioning the financial institutions do not really declare their entire non performing assets leading to situations wherein the institution could take a credibility beating on one of such hidden defaulters turning bad. Restructuring is also used as a window dressing tool to defer classification of such assets as non performing assets.
The moot question is how to address the issue.
It is already settled principle that many institutions are not covered by the provisions of section 43 D of the Income tax Act to defer recognition of income on bad and doubtful debts. Thus, all such financial institutions need to be taxed on the accrued income. The amount having been taxed will drive the institutions to realize the income. The co operative banks are a sector which need to be focussed on. Secondly, the Tribunals ruling against the settled judgement of the Supreme Court in the case of Southern Technologies needs to be overruled unilaterally by executive action or the Supreme Court taking cognizance of the same.
Secondly, the scheduled banks which are foreign banks need to be excluded from the provisions of section 43 D of the Income tax Act.
Thirdly, it needs to be pointed out that all institutions are entitled for the benefit of the provision for bad and doubtful debts being allowed as expenditure. This being the case the need for these institutions to exclude such income from accounting does not arise. It is only for the purpose of reduction of its cash reserve ratio that this computation needs to be made and not for the purposes of taxation.
Fourthly, the provisions of section 43 D by itself needs to be considered for removal to avoid the Government losing revenue on this count.
There is a need for monitoring such assets which are on the verge of moving from standard to sub standard, sub standard to doubtful and loss categories. The prevention of such downward movement is the first step towards fiscal discipline. Instead of mere focus on percentage of non performing assets to the advances, it is necessary to focus on the quantum of such lateral movements both upward and downward to assess the performance of the banks and financial institutions. If this is done, the scope for window dressing reduces as virtually all accounts are under the scanner instead of the ratio to gross advances and the provisioning adequacy. This would have ensured that accounts such as Kingfisher were identified much before they turn bad.
The next step would be to mark all restructured loans as non performing as they require to be monitored on a priority basis even higher to bad assets. This is due to the fact that in these cases a quantum of the interest is being foregone through the restructuring process. All such restructured assets require to be barred from moving Courts at the time of realization to avoid undue delays.
As a preventive measure granting loans on the basis of revenue stream with no collateral needs to be discouraged. Startups with innovative ideas with no fiscal backing need to be brought under subsidies rather than tampering with finances of financial institutions.
The above will make it clear that the issue of non performing assets may mop up finances but will not rid the system of counterfeit notes, unaccounted money stashed or hoarded away nor flush into the system the currencies which are hoarded. In fact, the current process is not demonetization but a process of replacing currencies with new ones. The difference being that the entire notes were sought to be sucked in before the new currencies were deployed to have the desired shock impact on hoarders and counterfeiters.
In fact, the impact would have been better had the decision been to replace the same with more of lower denomination notes such as Rs 10/-, 20/- and 50/- besides 100/-. This would have ensured that the common man did not face hassles. Even now the decision to release the Rs 2000/- notes ahead of the Rs 500/- notes is puzzling as the system does not have the required lower denominations for utilization. This also brings out the moot point that any decision requires field level inputs rather than intellectual decisions put through and addressing them with off the cuff solutions.
The biggest spin off of this effort is we have now a new slogan - Jai Jawan, Jai Kisan, Jai Vigyan, Jai Bankman
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