The Gujarat High Court order dismissing Essar Steel’s plea against the Reserve Bank of India (RBI) for listing it among the 12 companies to be treated under the bankruptcy law has given hopes for quicker resolutions of the bad loan problem in the banking sector. This isn’t the only reason. Just recently a study by industry body Assocham had even said that equipped with the bankruptcy code, the Reserve Bank of India (RBI) is expected to put non-performing assets (NPAs) worth about Rs 8 lakh crore for resolution by March 2019.
Such a quick resolution of India’s bad loan problem is, at best, wishful thinking unless certain pre-requisites are met.
First, there isn’t the required infrastructure in place as of now to initiate a large number of bad loan cases, involving huge amounts, where no significant repayment has been made for years. This is something senior bankers like State Bank of India (SBI) Chairman Arundhati Bahattacharya has highlighted as recently as last week (read a Business Standard copy here). This involves creation of an information system that tells bankers and National Company Law Tribunal (NCLT) the details of the defaulted borrowers. Without this, the much-hyped bankruptcy code may not be of big help to the banking system, Bhattacharya had said.
The SBI chairman clearly has a point here. In fact, this is an issue this author has highlighted in an earlier column. The question then raised was whether NCLT, the main agency that will make the Insolvency and Bankruptcy Code (IBC) scheme work, has adequate infrastructure to deal with a large number of insolvency cases? Right now there are about 25,000 pending cases with NCLT and according to Alvarez & Marsal (read a Mint report here), it may take at least seven years to resolve these pending cases. That doesn’t sound like an early resolution.
There are 4,000 pending cases in the Company Law Board (CLB) that will likely move to NCLT, besides 700 pending cases at Board for Industrial and Financial Reconstruction (BIFR), 5,200 winding-up and amalgamation cases in high courts and 15,000 cases in Debt Recovery Tribunal (DRT) related to corporates — all of which are expected to be transferred to NCLT. But with just 11 benches and 62 judicial and technical members, the report explains, NCLT will not be able to handle the mountain of pending cases. Unless the infrastructure is in place, the expected benefits out of the bankruptcy code will remain on paper only.
Second, there is a reason why banks haven’t already rushed to the tribunals till the time the Reserve Bank of India (RBI) has pushed them. In many cases, particularly with respect to engineering and manufacturing companies, money is stuck for years in stalled projects, where the reasons for stress are often sector-specific and linked to poor economic activity. “Unless these sector specific issues are solved, it is very difficult to improve the performance of these companies and enable them make repayments to banks,” said a former executive director with a Mumbai-based bank.
For instance, bad loans in the agriculture sector won’t come down unless farmers’ income profile improves. For this, we need better warehousing facilities to store crops and abolish middlemen. The steel sector will need policy hand-holding to prevent foreigners from dumping cheap products; small and medium entrepreneurs (SMEs) need simpler solutions to access equity funding and export policies. Unless sector-specific problems are not addressed, NPAs won’t disappear.
Third, pushing a company to NCLT for bankruptcy proceedings itself doesn’t guarantee recovery of money for banks. Once banks approach NCLT for resolution, a maximum of 270 days are given to the company to work out a turn-around mechanism and repayment of loans. If no resolution is reached, liquidation process begins. There are only two options before banks at this stage—either to sell off the company in whole to a potential buyer or sell it in parts to different parties much like a scrap sale. The machinery, land, plant all can be sold separately. Now the question is, what if there are no buyers to buyout the company? If part-sale happens, banks will receive a pittance only. In cases where bad loans plus the accumulated interest works out to be much more than the saleable assets of the firm, banks may not get much at the end of the process.
Fourth, the IBC will actually increase the capital requirement of banks. Banks will have to make a tad higher provision on loans that are referred to NCLT. Also, as pointed out earlier, typically a firm is pushed for liquidation following severe financial stress and erosion in its net worth. Hence, in many of the insolvency cases, banks may have to take substantial losses.
In the case of public sector banks that are major bad loan victims of India’s banking sector, the onus of recapitalisation falls upon the majority stakeholder in these banks, which is the government. Can the government fork out significant amounts of money to compensate the losses of state-run banks? It is doubtful.
An estimate released on Tuesday by India Ratings and Research said that Indian banks need to provide a bare minimum of Rs 18,000 crore additionally towards the 12 accounts identified by the RBI for reference to the NCLT under the IBC. The additional provisioning, the agency estimates, will eat into banks’ profits by around 25 percent in FY18. Out of the total Rs 18,000 crore required for provisioning, the iron and steel sector contributes around Rs 10,500 crore and the infrastructure sector Rs 4,100 crore, the agency said. In a banking system dominated by state-run banks (70 percent by assets), all this means is that the Narendra Modi government will have to face a substantial capital burden. Sooner or later, the government will have to privatise these banks.
The current stock of bad loans was accumulated over years for reasons ranging from genuine industry difficulties, corporate-political nexus and reckless lending by banks among others. Any experienced banker will tell you that an early resolution to the Indian banks’ bad loan problem isn’t likely. It will take many more years of hard work and extraordinary political will to clean up the ailing banking industry.