18 things former RBI Governor Raghuram Rajan said should be done to tackle NPAs and other Indian banking sector woes

Former RBI Goverr Raghuram Rajan's response letter to Parliamentary Committee on Estimates regarding NPAs, apart from his views seemingly demystifying various topics over which re has recently been much deliberation, also contains a number of suggestions for action on NPAs and on or banking matters. 

Here are some of  things Raghuram Rajan said must be done, in his letter:

1. On Fraudsters: RBI set up a fraud monitoring cell when I was Goverr to coordinate early reporting of fraud cases to investigative ncies. I also sent a list of high profile cases to PMO urging that we coordinate action to bring at least one or two to book. I am t aware of progress on this front. This is a matter that should be dressed with urgency.

2. NPA problem's solution: In sum, Indian evidence, supported by experiences from or parts of world such as Europe and Japan, suggests that what we were seeing was classic behaviour by a banking system with balance sheet problems. We were able to identify effects because parts of our banking system – private banks -- did t suffer as much from such problems. obvious remedy to anyone with an open mind would be to tackle source of problem – to clean balance sheets of public sector banks, a remedy that has worked well in or countries where it has been implemented. This is t a “foreign” solution, it is an ecomically sensible solution. It is something that has been repeatedly flagged by government’s own Ecomic Survey, under guidance of respected Dr. Arvind Subramanian. Clean up was part of solution, t problem. 

3. On recapitalisation of PSBs: government has t recapitalized banks with urgency that matter needed (though without
governance reform, recapitalization is also t like to be as useful).

4. Do's and Don'ts with regards to promoters involvement in Bankruptcy code proceedings: Bankruptcy Code is being tested by large promoters, with continuous and sometimes frivolous appeals. It is very important that integrity of process be maintained, and bankruptcy resolution be speedy, without promoter inserting a bid by an associate at auction, and acquiring firm at a bargain-basement price. Given our conditions, promoter should have every chance of concluding a deal before firm goes to auction, but t after. Higher courts must resist temptation to intervene routinely in se cases, and appeals must be limited once points of law are settled.

5. Bankers should be able to proceed without promoters: Banks and promoters have to strike deals outside of bankruptcy, or if promoters prove uncooperative, bankers should have ability to proceed without m. Bankruptcy Court should be a final threat, and much loan renegotiation should be done under show of Bankruptcy Court, t in it. This requires fixing factors that make bankers risk averse and that make promoters uncooperative.

6. High-level empowered and responsible group on cleaning up banks: We need concentrated attention by a high level empowered and responsible group set up by government on cleaning up banks. Orwise same n-solutions (b bank, manment teams to take over stressed assets, bank mergers, new infrastructure lending institution) keep coming up and thing really moves. Public sector banks are losing market share as n-bank finance companies, private sector banks, and some of newly licensed banks are expanding

7. (In Hindsight) What RBI should have done: RBI should probably have raised more flags about quality of lending in early days of banking exuberance. With benefit of hindsight, we should probably t have agreed to forbearance, though without tools to clean up, it is t clear what banks would have done. Forbearance was a bet that growth would revive, and projects would come back on track. That it did t work out does t mean that it was t right decision at time it was initiated. Also, we should have initiated new tools earlier, and pushed for a more rapid enactment of Bankruptcy Code. If so, we could have started AQR process earlier. Finally, RBI could have been more decisive in enforcing penalties on n-compliant banks. Fortunately, this culture of leniency has been changing in recent years. Hindsight, of course, is 20/20. 

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Under bro heing of "Improve governance of public sector banks and distance m from government."

8. On appointments to PSBs: Public sector bank boards are still t equately professionalized, and government rar than a more independent body still decides board appointments, with inevitable politicization. government could follow PJ Naik Committee report more carefully. Eventually strong boards should be entrusted with all decisions but held responsible for m.

(He ds) It would be good for old CEO and successor to overlap for a few months while y exchange tes. All more reason to delegate appointments entirely to an entity like Bank Board Bureau, and t retain it in government

9. On bringing in outside talent to PSBs: Outside talent has been brought in very limited ways into top manment in Public Sector Banks. re is alrey a talent deficit in internal PSB candidates in coming years because of a hiatus in recruitment in past. This needs to be taken up urgently. Compensation structures in PSBs also need rethinking, especially for high level outside hires. Internal parity will need to be maintained. re will be internal resistance, but lakhs of crores of national assets cant be held host to career concerns of a few.

10. Or risks: Risk manment processes still need substantial improvement in PSBs. Compliance is still t equate, and cyber risk needs greater attention.

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Under bro heing of "Improve process of project evaluation and monitoring to lower risk of project NPAs"

11. On project evaluation: Significantly more in-house expertise can be brought to project evaluation, including understanding demand projections for project’s output, likely competition, and expertise and reliability of promoter. Bankers will have to develop industry kwledge in key areas since consultants can be biased. 

12. On risk mitigation and contractually sharing risks: Real risks have to be mitigated where possible, and shared where t. Real risk mitigation requires ensuring that key permissions for land acquisition and construction are in place up front, while key inputs and customers are tied up through purchase agreements. Where se risks cant be mitigated, y should be shared contractually between promoter and financiers, or a transparent arbitration system agreed upon.  So, for instance, if demand falls below projections, perhaps an agreement among promoters and financier can indicate when new equity will be brought in and by whom. 

13. On incentivising promoters: Promoters should be incentivized to deliver, with significant rewards for on-time execution and debt repayment. Where possible, corporate debt markets, eir through direct issues or securitized project loan portfolios, should be used to absorb some of initial project risk. More such arm’s length debt should typically refinance bank debt when construction is over. 

14. Real-time project monitoring and appraisal: Financiers should put in a robust system of project monitoring and appraisal, including where possible, careful real-time monitoring of costs. For example, can project input costs be monitored and compared with comparable inputs elsewhere using IT, so that suspicious transactions suggesting over-invoicing are flagged? Projects that are going off track should be restructured quickly, before y become unviable.

15. An incentive structure for bankers:  incentive structure for bankers should be worked out so that y evaluate, design, and monitor projects carefully, and get significant rewards if se work out. This means that even while committees may take final loan decision, some senior banker ought to put her name on proposal, taking responsibility for recommending loan. IT systems within banks should be able to pull up overall performance records of loans recommended by individual bankers easily, and this should be an input into ir promotion and pay. 

16. On making NPA resolution process speedy and on protecting bankers' decision-making ability: Both out of court restructuring process and bankruptcy process need to be strengned and me speedy. former requires protecting ability of bankers to make commercial decisions without subjecting m to inquiry. latter requires stey modifications where necessary to bankruptcy code so that it is effective, transparent, and t gamed by unscrupulous promoters.

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Under broer heer, "Government should focus on sources of next crisis, t just last one. In particular, government should refrain from setting ambitious credit targets or waiving loans."

17. On abandoning due diligence to meet credit targets: Credit targets are sometimes achieved by abandoning appropriate due diligence, creating environment for future NPAs. Both MUDRA loans as well as Kisan Credit Card, while popular, have to be examined more closely for potential credit risk. Credit Guarantee Scheme for MSME (CGTMSE) run by SIDBI is a growing contingent liability and needs to be examined with urgency.

18. On loan waivers: Loan waivers, as RBI has repeatedly argued, vitiate credit culture, and stress budgets of waiving state or central government. y are poorly targeted, and eventually reduce flow of credit. Agriculture needs serious attention, but t through loan waivers. An all-party agreement to this effect would be in nation’s interest, especially given impending elections.