Bad loan crisis: Before banking on bankruptcy code, lenders should follow a carrot and stick policy

by / Saturday, 12 August 2017 / Published in News & Updates

The Insolvency & Bankruptcy Code (IBC) has laid down the way forward for lenders to expedite recovery and resolution of stressed assets while maintaining priority of claims in order. It also gives creditors more headroom to take a call on distressed assets and further strengthen the corporate bond market, which is fundamental to infrastructure financing today. Action is picking up on the stressed assets space and it is gathering momentum. Some of the biggest accounts are going to make their way to National Company Law Tribunal (NCLT) under IBC that have fund/non-fund exposure of above Rs 5,000 crore, where 60% or more has turned bad. It is a welcome sign for India’s crisis-ridden banking sector. If banks manage to recover these dud assets, it will give a major boost to the sector. Moreover, bad loan resolution would also help the government arrive at a more appropriate amount required by PSU banks towards their re-capitalisation. Also, I feel, that merging bad bank with a good bank as a way of getting a large good bank is no more a valid way of thinking as the government may end up with a large bad bank.

On paper, the gross bad loans of Indian banks are a little over Rs 7 lakh crore, but in reality the actual amount of bad loans would be far greater, given there is a big chunk of restructured loans—loans that technically remain standard on the books of banks, but are actually bad. As far as provisioning for these bad loans is concerned, almost 40-60% provisions would be needed on the steel alone and even larger provisions would be required for other sectors like power and infra. These amounts add up to a little over Rs 2 lakh crore, or about 30% of the Rs 7 lakh crore worth of gross NPAs in the banking system.

The way RBI has directed banks to initiate IBC against high value NPA cases inspires confidence. The central bank committee has taken a common cut off in terms of loan exposure and portion of loan that have turned bad, and has not named any company in public. This partly addresses the concerns of RBI cherry picking individual companies for punitive action. The tone of the guidelines more or less remains generic. As far as the procedure is concerned, whole process is time bound and offers a decent exit for the promoter and minimum financial losses to lenders. But, the problem is that banks are not experts in businesses to which they lend. Unless the right professionals are involved, a resolution within nine months may not be a workable idea and can lead to bigger disputes.

Before the application (to NCLT) is moved, the banks need to ensure that there is no specific leeway borrower had availed, either on bilateral basis or from the consortium (of lenders), which would be a hurdle during the proceedings. Under the IBC, once a case is admitted by the NCLT, a resolution plan must be in place within 180 days of admission. This is extendable up to 90 days. In case there is no plan or the committee does not agree on one, the company will go into liquidation.

Another problem the banks may face is the extent of haircut or losses they have to book to resolve the bad asset and the subsequent provisioning that will be required once bankruptcy proceedings start. Since the company is pushed for liquidation after severe financial stress; in many of the insolvency cases, banks may have no option but to book substantial losses upfront but atleast they would be able to get rid of the assets at whatever valuations they may get from the market.

NCLT here does not mean that the assets or firms referred to it are going straight into liquidation. The issue is that a resolution exercise has been slow as banks in a consortium are often unable to reach consensus. RBI is pushing the decision forward, since sometimes there being multiple lenders, some banks always are fearful of decision because of the consequences. If you look at the accounts RBI has cherry picked, the large ones, where banks have exposure of more than Rs 5,000 crore and going to NCLT, the rest of the banks have been prodded to try resolve the issues.

If we try to analyse the slippages in NPAs these are partly because of what is happening in sectors largely coming from infrastructure, steel, power/mining. The biggest hurdle which the law seems to have is the powers available to the lenders who can invoke IBC on Day 1 of default without giving any notification to defaulter. This can actually lead to some companies challenging the move as violation of their constitutional right to freedom. Such a law giving powers to creditors/lenders to decide whether to approve resolution plan or seek order for liquidation will have to undergo test of constitutional validity and other challenges too.

Moreover, if the companies have assets to offload, we don’t know who will be willing to buy it. It remains unclear what happens in case they don’t have adequate assets. Also, the liquidation value would be computed in accordance with internationally accepted valuation standards, after physical verification of the inventory and fixed assets of the corporate debtor. Further, it will also be a tough call for the investors in the stock of such companies, who will be on tenterhooks since equity shareholders are last in line to be compensated in case a firm gets liquidated.

In view of the current credit condition, it is imperative to strengthen the systems. The code definitely sends a strong signal to borrowers to adhere tocredit discipline and also encourages banks to break resolution deadlocks with definite timelines. Believing that a reference under NCLT means liquidation ‘only’ is not a right thing to believe. Liquidation is the end point when the creditors committee is formed who have all the options available to restructure, to look at the possibility of even the said merger, the change of management, all kind of possibilities are there. But the key part—implementation—still remains more or less un-addressed.

In almost 80% of the cases where companies are in financial distress, change of management or change of ownership will be key to long-term resolution of such stressed accounts. This will not only enable the new stakeholders to price the assets-based on its true earning capacity, but also help them restructure their repayment commitments in line with future cash-flow generation, with some upside being available for the new investor to take the required risk and allocate necessary capital. Under RBI’s current guidelines, it’s not possible for the accounts to get restructured without them being classified as NPA’s and the problem only compounds with time if the change of management route is not taken for such assets to restructure loans & repayment commitments in line with cash flow generations.

In such a scenario, the serious investors would like to commit time and capital only when they are certain about the process outcome and that’s where the new IBC code will help serious investors to place their bets thru NCLT on quite a few assets where financial turnaround seems possible. Thus, as of now, it is important that the correct infrastructure should be in place for the action to get going.

Source: http://www.financialexpress.com/opinion/bad-loan-crisis-before-banking-on-bankruptcy-code-lenders-should-follow-a-carrot-and-stick-policy/783164/

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