A research by RBI economists claims the equity market has reacted positively to the Ordinance that empowered the Reserve Bank to take stern action against large defaulters. Since the Ordinance and naming of 12 largest defaulters, the banking index gained over 5 per cent, says the report based on the stock performance between May 4 and June 13.
“The May 4, 2017 Ordinance amending the Banking Regulation Act has been positive for banks and their high quality borrowers but negative for the distressed firms, suggestive of its potential to rejuvenate banking sector health and to improve capital allocation across firms,” claims a research paper by Cafral. Cafral, or the Centre for Advanced Financial Research and learning, is one of the research wings of RBI. The note, titled 'Mint Street Memo No 03', is based primarily on the performance of bank stocks as also of the affected 12 largest borrowers who together account for a quarter of the total bad loans in the system that stood at over Rs 8 trillion, or 9.6 per cent of the total system.
The Banking Regulation (Amendment) Ordinance promulgated on May 4 empowered the RBI to direct banks to initiate insolvency proceedings in respect of default under the provisions of the Insolvency and Bankruptcy Code, 2016 (IBC). It also enabled the RBI to constitute committee/s to advise lenders on resolution of stressed assets.
The RBI on May 22 released a detailed action plan to implement the Ordinance. One of the aspects of the plan was the setting up on an Internal Advisory Committee (IAC), which held its first meeting on June 12 and recommended that all 500 accounts with an outstanding amount of over Rs 5,000 crore each, and 60 per cent of them being NPAs (as of March 2016) would qualify for reference under IBC.
Using these criteria, 12 of 500 such accounts were named by the RBI, which asked banks to start IBC proceedings against them. These 12 accounts - Bhushan Steel, Bhushan Power & Steel, Essar Steel, Amtek Auto, lanco Infra, Monet Ispat, Electrosteel Steel, Era Infra, ABG Shipyard, Alok Industries, Jaypee Infratech and Jyoti Structures - are under bankruptcy proceedings now. The paper claims that between the event date on May 5 (the Ordinance was issued after market hours on May 4) and the event window - that is nine trading days before the event date and nine trading days post-event date - the banking index made one of its biggest gains.
The response of the market is analysed by computing abnormal returns. An abnormal return is defined as the difference between realised returns and expected returns regressed over the estimation window starting 250 days prior to the event window and ending 30 days before the event date. The analysis focuses on the 36 banks for which stock market data is available. Those banks that have a NPA ratios above the sample median value for all banks in FY16 are classified as stressed banks.