Resolving bad loans
There is a flicker of hope for the Indian banking sector, which continues to find itself mired in a bad loan crisis. The Reserve Bank of India recently decided to step up the plate just when observers thought that there was no light at the end of the tunnel. In a significant development, the Central bank announced that its internal advisory committee would recommend 12 non-performing accounts, which it says account for about 25% of the country's total bad loans, for immediate resolution by undergoing bankruptcy proceedings.
The internal advisory committee was set up after the Centre amended Section 35 of the Banking Regulation Act through an ordinance. "The Central Government may by order authorise the Reserve Bank to issue directions to any banking company or banking companies to initiate insolvency resolution process in respect of a default, under the provisions of the Insolvency and Bankruptcy Code, 2016," says one-half of the ordinance. The second half of the ordinance goes on to state that "the Reserve Bank may, from time to time, issue directions to the banking companies for resolution of stressed assets." Prima facie, one might be tempted to raise questions of conflict of interest, considering the Central bank's involvement. In an ideal situation, regulators must stay away from involving themselves in the commercial decisions of the enterprises that they seek to regulate. Nonetheless, the hope among policy mandarins is that recently passed bankruptcy and insolvency law will facilitate the cleaning up process that banks' balance sheets sorely require. This is easier said than done.
At the end of March, the volume of non-performing assets (NPAs) for banks stood at a whopping Rs 7.4 lakh crore. Nearly 88% of these bad loans are stuck with public sector unit (PSU) banks.
As per a recent report by the Press Trust of India, these bad loans exceed the very market value of PSU banks. In a bid to address these concerns with greater urgency, these banks are taking a whole host of willful defaulters to the courts so that they can recover some amount through these legal proceedings. But considering how Debt Recovery Tribunals have performed in the past, these banks are stuck for the long haul. For the uninitiated, these courts were set up to deal with disputes arising between lenders and borrowers.
By all accounts, all the 39 tribunals set up have performed dismally in recovering debt for defaulters. As per the new bankruptcy law, however, it is the National Companies Law Tribunal, which will now oversee these cases. Once again, similar institutional concerns surround this judicial body's ability to clear cases in a time bound manner. As per some estimates, there are nearly 25,000 pending bankruptcy and insolvency cases already under its belt. Anyway, once the case is admitted, the Tribunal can appoint an insolvency professional to oversee individual accounts and suggest a plan within the period of six months. If the tribunal believes that the bad loan case under its jurisdiction is beyond any scope for resolution, it will initiate the process of liquidation. This is bound to be a time-consuming affair for the banks, and the entire process may not even yield the necessary results as the debts in question are greater than Rs 5,000 crore each, of which 60% have already been classified as non-performing. Financial analysts have opined that banks will be compelled to take haircuts—a term used to describe a bank giving up part of its claim from a borrower to get the business back on the rails or to clean its balance sheet.
Liquidation seems like the only viable option left for banks, but considering the downturn in the market, they would find it hard to find buyers for assets that have already undergone depreciation. In the past, the government and RBI have sought to find all sorts of ways to tackle the bad loan crisis. Chief Economic Advisor Arvind Subramanian had proposed the creation of a 'bad bank' to resolve the NPA problem will not see the light of day. The idea of a 'bad bank' had come up with the understanding that many of its earlier schemes—Flexible Refinancing of Infrastructure, Asset Quality Review and Sustainable Structuring of Stressed Assets, among others—has not produced the necessary results. Many have posed the argument that under the above schemes introduced by the central bank too much discretion was left at the hands of banks. In a bid to turn around stressed assets, the government has set up the Insolvency and Bankruptcy Board of India, besides, of course, passing the Bankruptcy Code through Parliament earlier in its tenure.
Policy experts contend that the problem of bad loans starts with the Reserve Bank of India. "The job of a sound banking regulator is to prevent such possibilities through prevention (micro-prudential regulation) backed by cure (resolution). For years, RBI adopted a lax approach which helped banks hide bad news. Had RBI been more vigilant and taken appropriate actions early on, the ongoing NPA crisis could have been prevented from metastasising. The amendment to BRA through this ordinance further increases the RBI's involvement in the commercial decisions taken by banks. However, the roots of the banking crisis lay in RBI's own internal functioning. This calls for improving the regulatory architecture, accountability mechanisms, and processes for executive/legislative/judicial functions.
These are not seen in the ordinance," writes Pratik Datta, a noted researcher with the National Institute of Public Finance and Policy, in a recent column for an Indian news website. The bad loan crisis, a legacy of state interference in the financial decision of public sector banks and weak overall regulation, has stymied the flow of bank credit. This lack of credit in the system has brought the wheels of the economy to a grinding halt. NPAs in our public sector banks represent a massive transfer of wealth from the Indian taxpayer to India's business empires.