The Presidential Ordinance empowering the Reserve Bank of India to enforce expeditious resolution of non-performing assets of banks should hardly come as a surprise. For several past weeks, Finance Minister Arun Jaitley has been hinting at this legal empowerment of the central bank to crack down on NPAs of banks, an area where recovery has been a painfully slow process.

But the jury is still out on whether these changes will make a significant dent on the magnitude of the problem – and if it does, how soon some positive results would flow in to make a favourable impact on the economy, the banking sector’s lending behaviour, and the country’s investment climate.

Make no mistake about the enormity of the problem. The total size of the banking sector’s NPAs is estimated at over Rs 6.7 lakh crore, of which no less than Rs 6 lakh crore is accounted for by state-owned banks or public sector banks.

What then are the implications of the ordinance for the bank NPAs?

Government to the fore

One, the Union government has now empowered itself to direct the RBI to take necessary steps to initiate the NPA resolution process once a default has been established. The earlier provisions of the Banking Regulation Act did not allow the government to direct the RBI to enforce NPA resolution for cases of default.

This is a significant change. At one level, it allows the Union government a toehold into an area that was strictly the domain of the central bank. Purists may find this objectionable on the ground that it undermines the central bank’s authority over such matters.

At another level, it projects the role of the political establishment as a proactive agent in bank NPA resolution. After all, NPA resolution under the amended law can take place on specific directives of the Union government.

Political risks and opportunities

Politically, it is both an opportunity and a risk. It is an opportunity because successful resolution of bank NPAs can be projected as the government’s success in cracking a hard nut – one that the previous government failed to tackle and allowed it to grow into a bigger problem.

It can also be a political risk because this will expose the government and the political establishment to charges of having used discretion to pick and choose the default cases requiring NPA resolution, resulting in more or less haircuts for some borrowers and lenders. Opposition political parties might argue why for instance an X industrialist got a better deal than a Y industrialist. Charges of bias against such government initiatives can be a potential danger.

Linkage with Bankruptcy Code

There is also an associated implication of the ordinance in the manner that the provisions of the Bankruptcy Code have now been linked to the Banking Regulation Act. Prior to the Union government directing the RBI to initiate the NPA resolution process, the government now has to establish the incidence of a default as defined under the Code. So far, the linkage between the Bankruptcy Code and the Banking Regulation Act was not there and could have come in the way of the central bank taking action against any bank for ignoring a default.

Closer supervision

The Ordinance also allows the RBI to set up oversight committees for banks with NPAs that remain a matter of concern requiring early resolution. This will certainly empower the central bank to enforce a closer supervision of banks with sticky loans. Finding professionals to steer these oversight committees will be a challenge, but the ball, as far as increasing oversight of such troubled banks is concerned, will be in the RBI’s court.

Expect, therefore, some government-guided and RBI-led action to tackle the NPA problem. And this action would certainly be different from the series of initiatives that the central bank has taken in the past few years. What has been witnessed since 2013, when Raghuram Rajan took charge at Mint Road, is a series of steps at tightening the norms of recognising sticky assets. That approach has been continued with similar vigour and minor variation by his successor, Urjit Patel, since he succeeded him in September 2016.

While these initiatives resulted in more stressed assets surfacing with the enforcement of more transparent recognition norms, there was, however, little progress in resolution of these NPAs. The bank managements, particularly those in the state-owned banks that accounted for almost 90 per cent of the sticky loans, were shy of settling deals that would clean up their balance sheet. That was because such decisions could also incur the wrath of the investigation and vigilance departments of the government for having entered into, what they would argue were, sweetheart deals. At the same time, the bank managements showed no firmness in forcing the borrowers to take haircuts and lose equity in the troubled projects for which the sticky loans were obtained. The result: There was no progress in the resolution of NPAs.

Regulatory reforms

The operation of the Bankruptcy Code helped the situation only up to a point. The policy as well as regulatory environment was such that asset reconstruction companies were unable to strike deals on buying sticky loans on which they hoped to make reasonable returns. On the other hand, the bank managements were not bold enough to sell the sticky assets to ARCs at such discounts as would make the deal remunerative.

This called for regulatory reforms that, on the one hand, would have allowed ARCs to be floated by private equity firms that could take the risks and, on the other, would have allowed banks to take the financial hit on such loans in return for a more healthy-looking balance sheet. Since such reforms did not take place, let alone being on the cards, nothing much changed as far as ARCs’ capability of making a dent on stressed banking assets were concerned.

The Presidential ordinance amending the Banking Regulation Act is an attempt to strike a balance between no visible improvement in the NPAs’ status as a result of banks’ slow recovery pace and the lack of effectiveness of the current legislative framework aimed at tackling the growing problem of the economy’s twin balance-sheet problem. Even if the ordinance can push the RBI and banks into some credible action at resolving their NPAs, the Indian economy is likely to get the benefit of both a less stressed banking system and a relatively deleveraged India Inc. But that, however, should not underestimate the importance of amending the Prevention of Corruption Act to ensure that genuine decisions taken by banking sector professionals are not hauled up on corruption charges.

This article first appeared on Business Standard.