Thread by @mosesharding

What’s the viable resolution for banking sector woes?

It’s important to identify the good, bad & ugly components of the banking sector (financial & non-financials) for this purpose - improvisation (of the good), course correction (of the bad) and eradication (of the ugly)...1/n

The ugly components which needs immediate attention: (a) Lowering of GNPA of banking sector from double-digit to <5% and NNPA to <2% with PCR of >60% (b) Dilution of Credit risk-aversion for better top-line productivity (c) improved cost-income for in-built growth capital...2/n

(d) above par standards on management of credit (fund & non-fund) and market (non-SLR investments/credit substitutes) risks, managing credit cost at maximum 15-25% of NII (e) ensuring 100% adherence to compliance & governance policies taking accountability for non-compliance..3/n

There’s been lot of suggestions in public domain on NPA resolution and what standout is (a) infusion of sufficient capital for provision coverage, and to treat NPA baggage as business centre to get recovery into P&L account (b) creation of bad bank to take out toxic NPAs...4/n

Option here is either to keep the issue in-house (retaining responsibility to the originator) or consolidate under new AIF (combination of ARC/AMC); Either of the option can’t be obviously funded by the exchequer when pre-Covid fiscal deficit is >5%; so, what’s the way....5/n

There’s no alternative to creation of “Banking Sector stabilisation fund” (TARP/AIF model) with agenda to either pump in desired capital to individual banks (in exchange for equity & debt) and/or to buy out toxic assets at market value, whichever options emerge as best fit...6/n

Catch in infusion of cash for equity for individual banks is aligned to book/market/enterprise value, and if capital requirement (for on-going/sustainability/growth) is more than value, it’s non-starter with need to look at combination of equity & debt for viability...7/n

Option of buy out of toxic assets from individual banks would involve the seller to have sufficient capital reserves to absorb (fair value) provisions adjusted for capital to remain as on-going; post which growth capital be raised from public on better balance sheet numbers...8/n

So, in either of the said options - it’s tough to accommodate weak banks (in PCA or into PCA including C-19 book) with low RoA/PAT, needing option No.3 for resolution or trigger of “bail-in” concept, whereby liability side stakeholders lead & participate in reconstruction...9/n

It’s not easy (as talked about in the media & public domain) for NPA resolution when not many will fit into fair value model, and hence would need to look at either “bail-in” or forced M&A (with banks that fits into reconstruction providing equity adjustment for sacrifice)...10/n

major systemic issue is pushing financial intermediaries into lending beyond AAA/AA risk and to support MSME & unsecured borrowers; it’s not easy when credit risk aversion has worsen between pre & post-Covid environment, hence the need to think beyond liquidity & rates...11/n

Direct option is to either ensure better intermediation margin to lenders (to absorb higher credit cost) or provide credit guarantee comfort (against premium); what’s scenario on NIM? It’s 2 extremes now in declining cost of funds dynamics - segregated into Big7 & others...12/n

Big7 banks (3PSU + 4 Private) get the best benefit of declining cost of funds from trust deficit on others post PMC & YES Bank issues; on asset side, there’s significant NIM squeeze from lending to good risk & investment portfolio, which account for 35-50% of asset book...13/n

Balance 35-50% of assets on sub investment grade exposures (leaving ~15% for non-yielding fixed & other assets) will give high margin from elevated double-digit lending rate; combination of both makes it good for Big7 to stay aggressive on lending; but it’s not so...14/n

Other banks lose out on higher cost of funds and higher squeeze of margin from Investment grade lending & SLR book, while compelled to offer better lending rate to compete with Big7 on sub investment grade segment; it’s natural that this segment of banks is the worst hit...15/n

If the concept is agreeable to @FinMinIndia & @RBI and blessed by @PMOIndia then other modalities of ownership structure, funding (equity & debt), operating structure & policies etc will automatically sit in respective places! It’s big, but no choice but to bite the bullet...18/n

If these 2 equity & risk related issues are addressed, then need to focus on sustainability and doing better on other 3 critical non-financial matters; (a) Management of cost-efficiency (combination of productivity & efficiency) is mantra of foreign & new gen private banks...19/n

Mantra revolves around RoA management - higher NII (widening gap between interest income & expenses), equivalent other income (revenue generation beyond intermediation), optimisation of operating costs, cost of risk aligned to NIM and revenue focus from zero risk products...20/n

Current woes of banking sector is also attributable to low quality of risk management (with higher focus on reward) and dilution of importance on compliance & governance standards! It’s less said the better here! need reforms, and take comfort that work already in progress...21/n

Need to get decisive resolution on these 5 areas (flagged as ugly, needing transformation) given that banking sector as catalyst force is critical for economy, building aspirations for GDP growth into 6-7.5% & beyond;

It’s long, some other day on “good” & “bad” aspects...22/22

What said here is also relevant for Kenya, where @CBKKenya @KDICkenya have already begun banking Sector stability providing zero cost liquidity support (equivalent of quasi equity) & provision support for suitors from take-on balance sheet and tight regulatory supervision!