THE NEW NPA BAT­TLE

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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.

Past mea­sures

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.

New mech­a­nism

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.

First steps

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.

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