THE NEW NPA BATTLE
Many promising provisions of the new bankruptcy law appear to make it an effective weapon in banks’ onslaught on bad loans.
Many promising provisions of the new bankruptcy law appear to make it an effective weapon in banks’ onslaught on bad loans.
Last month, a Gujarat High Court verdict brought huge relief to banks badly battered by non-performing assets ( NPAs). The high court threw out a petition filed by Essar Steel, challenging its lenders against initiating bankruptcy proceedings against it. The Mumbaiheadquartered steel company had ar- gued that it was arbitrarily bunched up with 11 other loan- defaulting companies to face the bankruptcy proceedings.
The court's decision arms the banks to fight a fresh battle against bad loans - a mind- boggling Rs 7,28,768 crore as of March 2017 - under the new bankruptcy law - Insolvency and Bankruptcy Code (IBC), 2016. A year since the new bankruptcy law came into force, the Union government, the Reserve Bank of India (RBI) and the banks have stepped up their efforts to rid the system of sticky loans.
In May, the government passed an Ordinance to amend the Banking Regulation Act, 1949. The executive order empowers the RBI to direct banks to initiate bankruptcy proceedings against defaulters to recover bad loans. Empowered by the Ordinance, in June, the central bank asked lenders to initiate bankruptcy proceedings against 12 big corporate defaulters, including Essar Steel, Bhushan Steel, Monnet Ispat & Energy and Jaypee Infratech, among others. The 12 corporate houses have collectively run up NPAs worth over Rs 1,75,000 crore, which account for a little over 24 per cent of the banking sector's total sticky loans.
A new ecosystem
Meanwhile, the RBI and the lenders have taken the first, small steps to tackle the NPA menace under the new
bankruptcy law. Essar Steel did attempt to delay the lenders' loan-recovery process. But with the Gujarat High Court putting its foot down, the battle against bad debts seems to have got back on track.
The action has now shifted to the National Company Law Tribunal (NCLT), the authorised tribunal for dealing with the bankruptcy proceedings of companies and limited liability partnerships (LLPs). The 12 big corporate cases are at different stages of the bankruptcy proceedings at the NCLT. Besides, the tribunal, which has a principal bench in New Delhi and ten benches across the country, has already approved proceedings against 148 companies, including Ennore Coke, Educomp Solutions, Gujarat NRE Coke and Unity Infraprojects, among others. Many lenders - such as State Bank of India, Bank of India, ICICI Bank and IDBI Bank - and asset reconstruction companies (ARCs) - such as Alchemist and Edelweiss - have initiated insolvency proceedings against some bor- rowers and received the NCLT's approval.
The fledgling bankruptcy ecosystem - modelled on the bankruptcy systems in most developed countries - that has been put in place within a year, promises to deal with the NPAs in an entirely new way. The NCLT apart, yet another institution, the existing Debt Recovery Tribunal (DRT), has been designated to resolve insolvency issues of individuals and partnership firms.
The Insolvency and Bankruptcy Board of India (IBBI), the regulator for the entire bankruptcy ecosystem, is in place to monitor and regulate various stakeholders. The appellate tribunal, the National Company Law Appellate Tribunal (NCLAT), has also
been constituted for hearing appeals against the orders of the NCLT and the DRT. "The entire ecosystem of insolvency is already available to credi- tors and transactions are happening. I really do not have to do anything additional for this purpose," notes IBBI Chairman M S Sahoo.
Then there are a host of professionals and institutions, which have been set up, to take bankruptcy cases to their logical conclusion. Foremost among them are insolvency professionals (IPs), who will conduct the insolvency resolution process. These professionals, appointed by lenders, will take over the management of a company, against which a bankruptcy case has been filed, and assist the lenders in collection of relevant information and managing the liquidation process. Besides, insolvency professional agencies will examine and certify the IPs, while information utilities will collect, collate and disseminate financial information related to debtors.
Clear-cut procedures have been formulated in the new law to resolve bankruptcy cases in a time- bound manner. Any creditor or even a borrower can file for bankruptcy before the NCLT. Once the tribunal approves the case for bankruptcy proceedings, the entire process will have to be completed within 180 days. A one-time extension of 90 days may be granted by the tribunal.
Following approval of a bankruptcy case against a company, the banks will have to appoint an IP to take control of the debtor company's assets and its operations. A creditors' committee is formed to represent the interest of lenders and other affected parties. A resolution plan - which may include a revised loan repayment schedule for the company or a sale of defaulted loans to third parties, along with haircuts (settling loans at discounts) for lenders, or liquidation of the company's partial or whole assets - with approval of 75 per cent of creditors on the committee should be ready within the stipulated 180-day period. If no decision is made during the resolution process, the debtor's assets will be liquidated to repay the debt.
With such well-defined provisions, it is widely hoped that the new bank-
ruptcy law will deliver decisively on the NPA front. Of course, it is not the first time the issue of bad loans is being addressed. A number of measures and mechanisms introduced by successive governments to curb NPAs in the past has sadly achieved very little. On the contrary, the NPA problem has snowballed into a major crisis, threatening to derail the economy.
The DRTs, one of the earliest institutions set up for speedy adjudication and recovery of debts, have failed to deliver results in the past. The 38 DRTs across the country are struggling to cope with rising volume of loan- recovery cases. At the last count, DRTs were dealing with a backlog of cases worth Rs 4,00,000 crore. In fact, various tribunals, such as DRTs and Lok Adalats, could resolve less than 20 per cent of cases taken up during the last three financial years. Under the new bankruptcy law, these tribunals have only been entrusted with insolvency cases of individuals and partnership firms.
The Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act (SARFAESI), 2002, hailed as a godsend for harried secured creditors saddled with NPAs, has also unfortunately met with a similar fate. The Act empowers lenders to seize the assets mortgaged by defaulting borrowers with the help of a magistrate and realise the best price for the seized assets without the sanction of the court. The law has been effectively used against small borrowers. But lenders have developed cold feet when it comes to employing this Act against large borrowers.
Moreover, a legal loophole in Section 37 of the SARFAESI Act has made the law subordinate to the Sick Industrial Companies (Special Provisions) Act (SICA), 1985. With brilliant lawyers, big-ticket borrowers have taken recourse to the SICA and filed an application with the Board of Industrial and Financial Reconstruction (BIFR). Once a company approached BIFR, banks are simply unable to proceed against its promoters using the SARFAESI Act.
The RBI has also allowed banks to take over management control of chronic defaulting companies by converting their debt into 51 per cent equity. This allows banks to turn around the companies with existing promoters or, if necessary, by bringing in new promoters. But banks and ARCs face many practical problems. Solutions, like management change, are easier said than done as banks find it difficult to get buyers for defaulting companies.
In 2015, Raghuram Rajan, the former RBI governor, called for a deep surgery to clean up banks' books of bad debts by introducing new asset classification norms. Accordingly, all new restructured loans too were classified as bad loans. The new norms attracted the same amount of provisioning for restructured loans as for NPAs. This move was aimed at plugging the loophole of restructuring loans quite of- ten to prevent them from becoming NPAs. As expected, banks reported huge losses for the next two quarters due to huge provisioning. However, over a year after the new asset classification norms came into force, there is hardly any improvement in banks' sticky loans.
With no end in sight to the NPA crisis, banks are pinning their hopes on the new bankruptcy law to slash their bad loans. Moreover, many promising provisions appear to make the new law an effective weapon in the battle against bad loans. "The bankruptcy law is a game-changer in dealing with failure of enterprise which is part of business risks. Smooth exit of one entrepreneur and the entry of the other will mitigate risks of lenders and protect interests of other stakeholders," notes Srei Infrastructure ViceChairman Sunil Kanoria.
For one, the new law consolidates all existing bankruptcy laws in the country into a single statute. The IBC, 2016 replaces many laws dealing with insolvency of companies, such as SICA, Recovery of Debt Due to Banks and Financial Institutions Act and SARFAESI Act. Besides, the new legislation also updates provisions of a couple of laws dealing with individual insolvency dating from the time of the British Raj. The single law ends multiplicity of laws that impeded banks in their loan recovery.
"The entire ecosystem of insolvency is already available to creditors and transactions are happening."
M S SAHOO, Chairman, IBBI
A specific timeframe of 180 days with a one-time extension of 90 days in the IBC, 2016 makes the insolvency resolution process a rather swift affair. In the past, banks took as long as 15 years in certain cases to recover their money, which eroded the value of assets substantially.
According to a World Bank report, it took, on an average, more than four years to wind up a company in India. On the contrary, in China, a company could be wound up in about two years, while it took 1.5 to 1.7 years to wind up a company in the USA. The same report notes that creditors in India could recover only 25 cents to a dollar compared to 36 cents in China and a substantial 80 cents in the USA.
Before the IBC, 2016 came into force, it happened to be a prerogative of bankers to declare their assets as an NPA. Bankers would often carry the assets on their books at inflated values or restructure big-ticket loans - before the new asset classification norms were implemented - to avoid costly provisioning. A lack of transparency in declaring bad loans resulted in a pile-up of NPAs for years together.
The new bankruptcy law addresses this issue of transparency quite effectively. First of all, it ends the exclusive prerogative of bankers in declaring NPAs. Apart from bankers, trader creditors, employees and even borrower businesses themselves can trigger the insolvency-resolution process once there is a default of debt repayment.
The new law allows a debtor business to file a bankruptcy case, and once resolved, it facilitates the business to move on and start with a clean slate. According to the IBBA, of the 148 cases approved by the NCLT, some 56 cases have been initiated by the defaulters themselves. "If a corporate borrower is unable to pay his creditors, he can file a bankruptcy case at the NCLT. Once it is decided at the tribunal how much the borrower has to pay, and once that is settled, the debtor can have a fresh start," notes Nangia & Co Executive Director Neha Malhotra.
Under the new bankruptcy law, it will be very difficult for bankers to soften or sweeten the loan-recovery process swayed by corporate and political influence. Even if the creditors' committee is made up of a majority of bankers, it is broad-based with other stakeholder creditors, who will act to protect their interests and thereby expedite loan recovery. Besides, the IP, who wields considerable power in the bankruptcy process and, more importantly, whose fees would be proportional to effective resolution, will ensure that the due process is followed without fail.
Finally, two other reasons that perhaps got bankers to delay declaring a big loan account as an NPA seem to be effectively addressed. First, the government at the highest level has committed itself in resolving the longfestering NPA woes. This commitment, to a great extent, makes it difficult for political influence to come in the way of treating a loan account purely based on its economic merits. Second, senior bank officials would not risk their necks in writing off a part of a bad loan as they were scared of landing in the CBI's or the CVC's net for allegedly striking a sweetheart deal. Now, they will have no such fears as they will be acting under the RBI's directives.
The new bankruptcy law is certainly a vital piece of legislation that addresses the growing NPA menace - a major hurdle for economic growth. The gross NPAs in the banking sector are pegged at Rs 7,28,768 crore as of March 2017. The bad loans are definitely mind-boggling and account for about 12 per cent of banks' total advances and about 5 per cent of the country's GDP.
Besides, according to a recent re-
"The entire ecosystem, including insolvency professionals and tribunals, is still building capacity and capabilities." ASHISH CHHAWCHHARIA Partner, Grant Thornton "Some of the best and ethically-run companies have NPAs, and it has largely been because of slow decision-making." SHOBANA KAMINENI President, CII
port by Credit Suisse, the total stressed assets in the banking sector (including gross bad loans, restructured advances and written-off loans) at over Rs 14,50,000 crore make up a whopping 20 per cent of banks' total loans. In fact, the country's 50 top stressed loans at a jaw- dropping Rs 11,50,000 crore, owed by big corporate houses, account for over 80 per cent of banks' total stressed assets.
To be fair, India Inc has had a tough time in the past few years with global economic slowdown and a host of domestic issues bleeding their balance sheets and impacting their loan repayments. "Some of the best and ethically-run companies have NPAs, and it has largely been because of slow decision-making. But when you start adding interest upon interest, it balloons," opines CII President Shobana Kamineni.
However, most of the mess in the banking system is undoubtedly because of an unholy nexus between bankers and business houses in collusion with the political class. Apart from the moral issue, the NPA crisis also has serious economic implications. The huge amount of money blocked as NPAs does hurt banks the most. This huge blocked capital also crowds out genuine borrowers, such as cash-starved entrepreneurs, farmers and small businesses, and makes taxpayers pick up the tab for bailing out inefficient banks.
Freeing up this money is vital for economic revival, and the IBC, 2016 tries to do just that. But the process brings with it pain for the banking sector. The success of bankruptcy resolution rides on banks' ability and willingness to right-size their debt and take huge haircuts.
According to Nomura, a majority of resolutions could be around rightsizing of debt by around 50 per cent and forcing sale of non-core assets. Balance sheets could erode further if the resolution fails and companies go into liquidation. This could entail steep haircuts of 80 to 90 per cent for banks. It is a bitter pill that banks have to pop to clean up years of mess off their books.
Meanwhile, experts caution that it would be naive to expect the nascent bankruptcy law to cleanse banks' balance sheets immediately. There could be more legal battles ahead with promoters as banks try to take control of their companies. Then there is also the question of necessary infrastructure. "One needs to evaluate if the necessary infrastructure for executing so many bankruptcy cases within a stipulated timeframe is available. The entire ecosystem, including insolvency professionals and tribunals, is still building capacity and capabilities," points out Ashish Chhawchharia, a partner of Grant Thornton Advisory.
As the bankruptcy law takes its course, there is an urgent need to address structural issues within the banking system. The root causes for high NPAs, such as inadequate credit appraisal systems and shoddy lending practices, cannot be ignored any more. Moreover, there is an urgent need to professionalise and depoliticise the governance structure.
The government has rightly taken the first decisive steps by setting up the Banks Board Bureau. The vital institution, which deals with appointment of top management of government-owned banks among other issues, is slowly but surely infusing professionalism and governance within the banking system.
Undoubtedly, banking is a complex business. Loans can go bad because of business environment, bad business models and lapses on part of the banking system. A strong bankruptcy law not only facilitates smooth loan recovery process. It also provides an opportunity for enterprises - both big and small - to restructure their businesses, settle their debts and have a fresh start.
The bankruptcy law, in essence, spurs robust businesses and sustained economic growth. India has made a good start by filing bankruptcy cases against the 12 big corporate defaulters. All eyes are now on the new bankruptcy ecosystem to slash the mounting NPAs and recharge economic growth.
"The bankruptcy law is a gamechanger in dealing with failure of enterprise which is part of business risks." SUNIL KANORIA V-C, Srei Infrastructure
The National Company Law Tribunal has already approved bankruptcy proceedings against 148 companies.
An empowered RBI is directing banks to initiate bankruptcy proceedings against defaulters to recover bad loans.
DRTs are dealing with a backlog of cases worth Rs 4,00,000 crore.
Indian banks' loan recovery was a mere 25 cents to a dollar against 36 cents in China and 80 cents in USA.