Many things have been tried by the government and the Reserve Bank to fix the problem of bad loans that have plagued India’s banking system for a long time—from debt recovery tribunals to the scheme for sustainable structuring of stressed assets—but with little success. The Insolvency and Bankruptcy Code implemented five years ago was widely seen as a solution that would work. It had some initial successes. But after that recoveries fell sharply and cases started dragging on, putting some banks into an existential crisis.
Now the government has a solution for that—a bad bank, which will take over a chunk of the non-performing assets from banks, thus reducing the stress on their balance sheets while also trying to get a better resolution for the assets.
Bad banks, or asset reconstruction companies (ARCs), are nothing new in India, but their impact has been limited as they were all in the private sector. The process of sale and transfer of bad loans to private ARCs has been very slow owing to valuation issues and the huge upfront capital required to buy large non-performing assets. The government bad bank, or the National Asset Reconstruction Company Ltd, is expected to address such problems. “The NARCL is expected to buy out Rs2 lakh crore of bad assets over time, which would be 45 per cent of what all ARCs have collectively acquired till March 2021. That’s sizable, not only in the context of banking sector NPAs but also for the ARC industry,” said Krishnan Sitaraman, senior director and deputy chief ratings officer at the ratings agency CRISIL.
In the first batch, bad loans worth Rs90,000 crore are expected to get transferred to the NARCL.
The NARCL and the India Debt Resolution Company (IDRCL) will play a critical role in the management and resolution of large corporate bad loans. The NARCL, in which state-owned banks will hold 51 per cent stake and private sector lenders the rest, will aggregate and consolidate stressed loans. It will pay up to 15 per cent of the net asset value upfront in cash and security receipts will be issued for the remaining. The government will provide Rs30,600 crore guarantee for these security receipts.
“The sovereign guarantee will support the regulatory provisioning requirement of the RBI and allow banks to free up that capital without the burden of additional provisioning, effectively allowing more participation from the banks to resolve their NPAs through the bad bank,” said Anish Mashruwala, partner, J. Sagar Associates.
The IDRCL, in which public sector banks and financial institutions will hold 49 per cent, will manage the assets and engage market professionals and turnaround experts.
Some of the NPAs are several years old and recoveries in such cases have been dismal. “The average recovery run rate of insolvency proceedings barring certain large assets has been early double digits. Most of the Rs90,000 crore in the first phase will accrue from the list one and two that the RBI had asked the banks to move to the insolvency process a few years back. Chances of material recovery from these assets look bleak,” said Nilanjan Karfa and Amit Nanavati, analysts at Nomura Securities.
So, how efficiently the stressed assets are resolved under a new mechanism will be a key thing to watch. “One can argue that the bad bank is likely to become a warehouse for stressed loans without expected recovery, as it will be difficult to find buyers for legacy assets,” said Kunal Shah, an analyst at ICICI Securities. “If initial cash receipts are more or less equivalent to the amount invested by banks, would it then be merely shifting the problem from one place to another without fundamentally solving it?”
It might, however, to an extent solve the problem of banks getting shortchanged in resolutions. According to the Insolvency and Bankruptcy Board of India (IBBI), as of June 30, 2021, there were 396 insolvency cases with approved resolution plans. Of the total claims of more than Rs6.82 lakh crore, financial creditors could recover just under Rs2.46 lakh crore, which is just 36 per cent.
In the approved resolution of the bankrupt Videocon, billionaire mining baron Anil Agarwal’s Twin Star Technologies’ offer was Rs2,962 crore. The admitted claims were to the tune of Rs64,838 crore, which meant lenders would have to take a haircut of more than 95 per cent. Bank of Maharashtra, which had a small portion of the loan, appealed against the order in the National Company Law Appellate Tribunal and obtained a stay.
More recently, on August 12, the Chennai bench of the NCLT ordered the liquidation of Siva Industries and Holdings. The erstwhile promoters of the company had offered a one-time settlement of Rs328.21 crore, which was rejected by the tribunal. The admitted claims in this case from financial creditors were Rs4,863.87 crore. The claims from operational creditors and other creditors were Rs461.02 crore and Rs40.55 crore, respectively.
In the resolution of the bankrupt carrier Jet Airways, which has been sold to a consortium of Kalrock Capital and Dubai-based businessman Murari Lal Jalan, financial creditors would recover only 5 per cent of their total claims of around Rs7,807 crore.
Legal experts blame lenders for accepting such lowly payouts in some of these resolutions. “India’s bankruptcy resolution system is hampered by low recoveries and long delays. Banks got a bad deal in the cases of Videocon and Jet Airways and this was due to creditors’ acceptance of an unreasonable bargain,” said Sonam Chandwani, managing partner at KS Legal and Associates.
Creditors lose patience because many cases have been going on for a long time. The IBC stipulates that the resolution process be completed in 270 days. However, IBBI data shows that 79 per cent of the ongoing cases have exceeded the time limit. “The IBC intended to expedite the corporate insolvency process; nevertheless, the lag caused by litigations has crept into the process,” said Chandwani.
In the initial years of the IBC, some large NPAs, like Essar Steel and Bhushan Steel, were resolved and creditors recovered a fair bit. In the Essar Steel case, for instance, the lenders recovered 92 per cent of the Rs49,000 crore claims.
One reason behind the low recoveries now is that many of the underlying assets have lost their value over time. “Any buyer that is coming in is buying for the current worth and not for the value that banks have on their books,” said Tarun Bhatia, MD and head of South Asia for Kroll, a provider of services related to valuation, governance and risk. “What is outstanding with the banks is not an input to the valuation itself. If a certain company has lost its core value, then the buyer is only going to pay for certain benefits.”
Videocon, for instance, had acquired Thomson’s colour picture tube business a decade ago, which will command little value today for a buyer given that most of the world has switched to LCD and LED televisions. In the case of Jet Airways, most of the planes were leased and offices rented. The slots it had commanded had also been allocated to other airlines.
Some of the NPA accounts have also been declared as fraud by banks, where there was usually a disconnect between the assets and the loans. “A buyer will only offer to pay that much amount based on the actual assets on the ground and the utility of the assets to him. If an entity borrowed Rs100 and the assets are worth only Rs50, then you can’t expect the buyer to pay anything more than Rs50,” said Jindal Haria, director at India Ratings and Research.
Experts say, to avoid huge haircuts, lenders should initiate the insolvency process early when a stressed company is still operational. That way, there are chances that the value of the asset could be maximised. Also, say analysts, lenders should keep a watch on how loans were used by companies.
The IBC has been a step in the right direction. But, changes may well be necessary if it is to become more efficient.