Bad loans: Are we celebrating the outliers?

To the loud, self-congratulatory tweets of policymakers and politicians, supported by the media (which is quick to declare a few data points as a major trend), India’s bankruptcy law has been hailed as a runaway success. The first data point is Tata Steel’s successful takeover of Bhushan Steel. Tata Steel paid ~364 billion, out of over ~560 billion that Bhushan owed, benefiting some near-bankrupt public sector banks (State Bank of India being the biggest lender) and attracting epithets like “historic breakthrough” and so on.

The next big data point will be the resolution of another large steel asset, which has been kept alive by the shady lending practices of public sector banks (PSBs) for two decades — Essar Steel, which owes over ~570 billion, again mostly to PSBs, led by SBI. Earlier, Monnet Ispat was smoothly taken over by JSW Steel, and Electrosteel Steels (SBI was top lender) is about to be sold to Vedanta. And then there are a few stray anecdotes where promoters have put in money to gain control over their assets or get eligible for bidding. Seeing patterns and extrapolation is a natural human tendency and a few data points have convinced many that the bad loans mess will be fixed by the Insolvency and Bankruptcy Code (IBC) and banks will turn healthy.

Unfortunately, there are two huge problems with this rosy scenario: One, the sheer size of the existing stock and continuous flow of bad loans. Two, poor management of PSBs, about which nothing effective is being done. According to a conservative estimate, the size of the bad loan problem is about ~10 trillion. According to more reliable estimates (such as that of career banker KC Chakrabarty, former deputy governor of the Reserve Bank and former chairman of Indian Bank and Punjab National Bank), ~20 trillion is a more plausible figure. The steel assets — which are now in demand, only because the steel business is booming and have a few large players capable of paying for them — may fetch around ~1 trillion, or 10 per cent of the conservative estimate, or just 5 per cent of the realistic estimate. This is not enough to start a fresh lending cycle of PSBs as some commentators have predicted. What policymakers and media commentators ignore, the market does not. There has been no excitement about PSBs’ stocks, no matter what the effusive headlines say about the few successes of bad loan resolution. Meanwhile, PSBs continue to declare more and more losses owing to bad loans.

If we extrapolate the successes of a few trophy assets in steel, we will miss the fact that there are three possible outcomes of the IBC, of which the first and third are outliers. First, banks can get a substantial part of their money back only from businesses that are large and viable. We are witnessing this exceptional situation in steel, where the business prospects are so good right now that buyers willing to pay up huge amounts to grab what seems like one-ina-lifetime opportunity, even for massively gold-plated projects, from which promoters have siphoned off a lot of money.

The second outcome of the IBC is promoters stepping forward to settle their bad loans in order to continue keeping control over their assets, or, for fear of losing control through liquidation. But this too would be an outlier. The model in India has been to inflate project cost, siphon off money and go back to the bank to borrow more. If this is done multiple times, gold-plating becomes too huge to resolve but then the promoters will (have) neither the money nor the inclination to buy their own inflated assets with personal money. It is a grey area, rife with deal making between banks, resolution professionals and front companies, allowing promoters to get control again. One of the top 12 companies being monitored directly by the Prime Minister’s Office is trying this trick.

The third outcome of the IBC, for businesses that are small or unviable, is to quickly bury them, with no chance of banks getting back any money. For all the hoopla over Bhushan Steel, note that Alok Industries, which owes ~300 billion to lenders (that blue chip bank, SBI, again is the lead banker), may have to be liquidated, in which case banks will end up with pennies. You won’t see any minister, bureaucrat or advisor tweeting about it, though. This means that there will perhaps be no graded recovery. Either banks get a lot of money (the few outliers) or get very little (the vast majority). The SBI chairman has been quoted as saying that he expects 25 per cent recovery from the second lot of cases with the National Company Law Tribunal — that is beyond the 12 high-profile cases that are being monitored by New Delhi very closely. It is not difficult to guess what banks will recover from the millions of accounts which are small or non-viable. The real benefit of the IBC is that it may ensure a quicker resolution of bad assets than at any time in the past. It has nothing to do with why bad loans are rampant among PSBs, which is what we should be addressing with real seriousness, or how to prevent this cycle being repeated for the umpteenth time.