In this article, Akanksha Baghel does an analysis on bad debt crisis in India.
Bad Debt Problem
India’s banking industry is in the throes of a crisis. Bad debts are piling up at banks. According to the statistics provided by Reserve Bank of India (RBI), Gross Non Performing Assets (NPA) is INR 6120 Billion and the percentage of variation is 89.3 in the economic year 2015-16 as against INR 3233 billion and 22.3 percentage variation in 2014-15. The business of Scheduled Commercial Banks (SCBs) also slowed significantly during 2015-16. The Gross Non-Performing Advances (GNPAs) ratio increased sharply to 7.6 percent from 5.1 percent between September 2015 and March 2016, largely reflecting a reclassification of restructured standard advances as non-performing due to Asset Quality Review (AQR). A special inspection was conducted by RBI in 2015-16 in the August-November period and was named as Asset Quality Review. The profitability of SCBs declined significantly and the public sector banks (PSBs) recorded losses during 2015-16.
Understanding Bad Debt
A bad debt is a debt that cannot be recovered. Insolvency refers to a situation where any person or a body corporate is unable to fulfil its financial obligations (often occurring due to several factors such as a decrease in cash flow, losses and other related issues). Bankruptcy, on the other hand, is a situation whereby a court of competent jurisdiction has declared a person or other entity insolvent, having passed appropriate orders to resolve it and protect the rights of the creditors. An asset becomes non-performing when it ceases to generate income for the bank. With a view to moving towards international best practices and to ensure greater transparency, \’90 days\’ overdue norms for identification of NPAs have been made applicable from the year ended March 31, 2004.
This article is a discussion on the reasons behind the bad debt problem of India, its impact on the Indian Economy, changes introduced in insolvency proceedings by the Insolvency and Bankruptcy Code, 2016 and the impact of the Ordinance to amend the Banking Regulation Act, 1949.
Reasons for compilation of bad debts in the Indian Economy
One reason for compilation of bad debts in Indian Economy is the sluggish domestic growth. During 2004-08 economic growth encouraged banks to give more and more loans. The investors wanted to scale up their projects and they expected that the economy will grow just like it did previously. The banks too freely lent to those project without carrying out proper checks. But then in 2008 as a result of the financial crisis, things went downhill.
Many of these projects which stated with extended financing stalled. Earlier in 2000 when banks were suffering from bad loans, economic growth helped banks to recover from the loss. But this time when bad loans are higher than ever and world economy is also not doing well, this has further increased the problem. Global uncertainty has led to lower exports of various products such as textiles, engineering goods, leather and gems.
Another reason is the ban on mining projects and delays in clearances that affected the power and iron and steel sector. Yet another reason in a few cases was corruption and undue influence which affected lending decisions. Some companies were involved in fraud as well. But these were minor cases compared to the bad decisions taken by the banks of not carrying out proper checks.
Also, not extending throughout support to troubles is one of the causes. Therefore there were many projects which could not be completed due to various reasons and were not able to return money lent by banks. Banks stopped lending further money to them because of further increase in NPAs, thus revival of those projects became impossible. Moreover, with projects getting delayed the investors started requesting banks to infuse more capital into the projects with the hope that the project can be turned around with the increased funding. In return for the additional funding, sometimes banks were given part ownership of the project. And the term of financing was re-negotiated. This is called as restructuring of loans. However, in these cases, the banks are the one who loses because by taking ownership of failing projects instead of walking away from them, the banks were absorbing the losses of the failing projects.
India’s bad loan problem is choking off new credit and dampening the economic growth. We have a credit market which doesn’t function very well because creditors can’t collect on their debt and credit ends up in the wrong places. Borrowing costs are high and banks don’t make money. Bad debt clogs the system. India’s robust growth slowed recently as a result of the government’s unexpected move last year to ban 86 percent of the nation’s currency in an effort to root out “black money,” currency on which taxes haven’t been paid. The move has produced widespread shortages of cash. Economic growth is expected to face challenges as long as banks here are saddled with enormous bad debts. For the corporate bond market to develop in India, we need to have jurisprudence, we need to have recourse, we need to have laws, and we need to have transparency.
Insolvency & Bankruptcy Code – Debt Restructuring in India
There are thousands of pending litigations for recovery of money, squarely due to overlapping jurisdictions of various laws governing insolvency resolutions and courts. Hitherto, there were about 12 laws concerning insolvency before Insolvency Bankruptcy Code, 2016 (IBC). Hence one consolidated law was brought in order to expedite the proceeding and resolve the matter in an efficient manner, by introducing the IBC, 2016 which got President’s assent on 28th May, 2016.
The code makes a significant departure from the existing resolution regimen by shifting the responsibility on the creditor to initiate the insolvency resolution process against the corporate debtor. If the default is above INR 1 Lakh (may be increased up to INR 1 Crore by the Government, by notification) the creditor may initiate insolvency resolution process.
The Code specifies a timeframe of 180 days after the process is initiated, plus a 90-day extension for resolving insolvency. It proposes to do so by creating a host of new institutions such as Insolvency professionals (IP), Insolvency Professional Agencies, Information Utilities and the Insolvency and Bankruptcy Board of India.
When a loan default occurs, either the borrower or the lender approaches the National Company Law Tribunal (NCLT) or Debt Recovery Tribunal (DRT) for initiating the resolution process. The creditors appoint an interim IP to take control of the debtor’s asses and company’s operation, collect financial information of the debtor from information utilities, and constitute the creditor’s committee. The committee has to then take decisions regarding insolvency resolution by a 75 percent majority. Once a resolution is passed, the committee has to decide on the restructuring process that could either be a revised repayment plan for the company, or liquidation of the assets of the company. If no decision is made during the resolution process, the debtors’ assets will be liquidated to repay the debt. The resolution plan is then would be sent to the tribunal for final approval, and implemented once approved.
Challenges Ahead
This is a progressive step but practically there are various problem too. The NCLT will face the biggest challenge in the process of transitioning existing cases to the IBC. The second concern related to the NCLT is regarding the case law that develops under the IBC. Given that it is a new law, the procedures and common practices under it need to develop independently from the case laws under the pre-IBC regime. IPs form the backbone of the IBC. Their role requires a fine balancing act, given that they are in charge of managing the debtor company and are accountable to the committee of creditors and the adjudicating authority for their actions. To ensure that the IPs perform their role without any misfeasance, well-defined entry barriers to the profession must be designed and the IPs must be closely regulated by the IBBI. The lack of IU infrastructure is going to be another challenge.
Banking Regulation (Amendment) Ordinance, 2017
On May 4, 2017, President Pranab Mukherjee promulgated the Banking Regulation (Amendment) Ordinance, 2017. This adds sections 35AA and 35AB to the Banking Regulation Act, 1949 (BRA). RBI can, under powers given to it by a new law, issue directions to any banking company to initiate insolvency resolution process. However, we must remember that the IBC is itself new. The institutional infrastructure for the IBC worked poorly as of yet. It will take time for IBC to work well. No doubt, the good news is that the government, as the owner of the country’s largely state-dominated banking system, seems eager for a solution but according to a study by professional services firm Alvarez & Marsal, a debt-recovery judge in India clears 360 cases a year on average, compared with 2.895 by his counterpart in a U.S bankruptcy court. In other words, the RBI’s efforts to ease strains in Indian corporate debt are likely to confront an already overburdened, ill-equipped, and under-staffed, inexperienced judicial bureaucracy with a history of poor productivity. Another issue with it is that the ordinance gives power to RBI to issue directions and even overrule the commercial judgements of the banker. However in true sense as a regulator the job of RBI should be to commercially motivate banks and RBI should blow the whistle when the rules are being violated. Because, commercial decision making is best done in for-profit private sector environments, not by the bureaucracies.
Adequate institutional capacity is essential to ensure that the IBC does not suffer from the predicament of earlier reform attempts such as the DRTs. Doing all of these needs time and needs proper planning. Rushing through the implementation of the new law may serve to improve India’s ranking in World Bank’s Doing Business report but may not result in a de facto improvement of the insolvency resolution framework, thereby defeating the very purpose of the IBC. The manner in which the IBC is currently being implemented seems to focus more on expeditiously operationalising the law rather than effectively implementing it. These concerns, if not addressed suitably, will defeat the purpose of enacting a new insolvency law to improve the recovery rate in order to promote the development of credit markets and entrepreneurship.
The next step after resolving the insolvency disputes is of “stressed assets”. What would happen to them? After IBC many Indian and foreign investors are interested in investing in the process of cleaning up of the stressed assets. However, there is an ongoing discussion regarding the set up of “bad bank” in order to provide India with a durable solution. The concept of bad banks and the proposed models would be discussed in my next article.
REFERENCES
- Master Circular – Income Recognition, Asset Classification, Provisioning and Other Related Matters – UCBs, RBI (July 1, 2013).
- Financial Stability Report, RBI (June 2016).
- Database on Indian Economy, RBI.
- Master Circular on Income Recognition, Asset Classification, Provisioning & Other Related Matters, RBI (July 1, 2010).
- Anita Raghvan, India’s Bad Debt is looking better to Investors (May 29, 2017).
- Andy Mukherjee, Indian Bad Debt’s Long Day in Court (May 7, 2017).
- Rajeshwari Sengupta & Anjali Sharma, Challenges in the Transition to the New Insolvency and Bankruptcy Code (Dec 15, 2016).
