Bailouts are not the answer
The directive on bankruptcies could help an economic revival
Indians should get used to the idea of bankruptcies as a purgative for the economy. On Tuesday, the Reserve Bank of India (RBI) said 12 accounts representing about 25% of the gross bad loans in the banking system would be eligible for immediate reference for bankruptcy proceedings. A combination of factors is at play for this to happen. First is that the country has a new bankruptcy infrastructure and, most importantly, a market-based Insolvency and Bankruptcy Board of India. Second is a hardnosed push to tackle the burden of non-performing assets that have been crippling the banking sector. The RBI has ordered banks to initiate bankruptcy proceedings against the country’s 12 largest loan defaulters with a combined debt burden of an estimated Rs 2 trillion. A number of banks will now be forced to write-off enormous amounts of bad loans though there is some prospect of being able to capture assets that could set off some of these losses.
Until now the fate of derelict companies has been left to court-appointed liquidators and politically appointed boards, which led to the Indian phenomenon of “sick” industries. The result has been large amounts of assets – land, machinery and even brands – that have been denied to the healthy parts of the economy. Worse, it contributed to a culture of setting up firms with the purpose of siphoning off money rather than actually trying to succeed in the market. Bankruptcy helps creditors the basis for not only seizing assets of defaulters but for shareholders to initiate criminal proceedings against the promoters.
Cleansing the non-performing assets that cripple the banking sector today is needed to revive India’s economic growth. But this time rather than the standard government bailout, it seems it will be done by driving many of these firms to the wall. This will inflict some new shocks to the economy, not least because it may also bring some banks to their knees as well. However, this will be all to the good. Bankruptcies are a means to start a process of economic revival and a reform that India has long been missing.