By Indroneel Das
In a bid to restore balance to the Non-Performing Assets (NPA) situation, the government and the RBI have taken a series of stringent, albeit necessary steps. One of the most prominent developments is the addition of two new sections to the Section 35A of Banking Regulations Act, 1949.
Implications Of The New Sections
Both these sections are essentially recovery enablers for lender banks. In the past, the insolvency and bankruptcy guidelines were opaque and lacked a proper timeline and a structured mechanism for the resolution of bad loans. The new regulations have allowed the government to issue directives to the RBI regarding assessment and reporting of defaulters. Further, the RBI can issue directives to the lender banks, regarding specific borrowers and how to initiate the insolvency and bankruptcy proceedings against them.
Challenges faced with a corporate entity
The major problem with corporate loans is that usually, it is a consortium of banks that have handed out loans to the corporates in need of big money. It is obvious that only some large banks with a corporate facing loan book, have the willingness and ability to provide such large sums of money to corporates and therefore, their name figures in the list of the many banks that have credit exposure to a particular corporate defaulter. Among these banks, an overwhelming majority- more than three-quarters of the total NPAs, are with the Public Sector Banks (PSBs). This gives the government all the more reason to push the RBI and the borrowers for an agile and well-structured resolution process. However, the new amendment does face some challenges that might render it meaningless, when faced with a corporate entity.
The positives of the New Banking Regulation Act
According to the new additions, either the lender bank or the borrower can trigger off the bankruptcy and insolvency proceedings. Either way, every next step is timeline based.
Currently, the banks have been given about 6-9 months to resolve the big NPAs. The most critical step, after the initiation of the proceedings, is the association of the concerned banker and the insolvency professionals. The insolvency professionals exercise a direct control over the process by taking over the board and for all practical purposes, the operations too, of the concerned company. This is the best way to ensure that the interests of the creditors are protected. The resolution professional is best placed to determine how much of the NPA can be recovered and returned to the creditors and in what order of priority. After assessing the same, the resolution professional reports it to the RBI, which will then ask the lender to take a haircut if needed. If the bank had any foresight and grip on its loan book, the haircut it has to take will already be well provisioned for. However, if it isnt provisioned for, it will be an unpleasant shock for the balance sheet and the income statement. The extent to which the loan is recoverable by the sale of distressed assets and freeing up of capital from wherever possible will be done. This will ensure that all major lenders with exposure to corporates will either get their money back soon or will take the necessary write-off once and for all. The same bad loan will not come back to haunt them in the quarters and fiscals to come.
Recently, many big companies including the likes of Essar Steel were taken to the NCLT (National Company Law Tribunal) by the directive of the RBI, which identified major debt-ridden companies.
The NCLT is also a specialized body that operates under the provisions of the Insolvency and Bankruptcy Code, to trigger credit recovery proceedings when asked to do so by the RBI, the lender, or the borrower.
The Pitfalls of the Act
However, there are many factors that can play spoilsport in this arrangement. The first, and probably the most obvious one, is that any major step that needs to be taken for the resolution of the NPA, needs the approval of the majority of the shareholders. Not always will the resolution proceedings resonate with the shareholders of a company that is still a going concern. In fact, some provisions may even require a special resolution, which means that 75% of the shareholders need to vote in favour of the move. This means that if a companys promoters decide to play spoilsport and vote against the resolution, they can make a mockery out of the resolution proceedings.
Since the NPA situation is at its peak now, it is critical that the criterion and guidelines for a company to be declared unfit to service its debt and be taken to the NCLT are clear. Vague decisions may negatively impact the economy. In the recent past, an example is the previously quoted case of Essar Steel. Essar has ever since, been arguing that even though it has a sizeable debt, it can manage it and continue operations. It is crucial to have consensus between the RBI, the lender, the borrower, and all the other involved bodies, regarding whether or not insolvency proceedings are needed.
Other Concerns
Also, the two new sections added to the act and Insolvency and Bankruptcy Code are both new. They themselves may not have the bandwidth and the supporting infrastructure, or the mechanisms to carry out the cleaning of the banking sector balance sheets on their own. India also has a lack of professionals who specialize in the handling of distressed assets and in the process of resolution. Given these, the new improvements to the act may yield low recovery rates.
Also, the time is ripe to take control of the board and consider partial or complete liquidation to support the debt servicing, when the company is a rather new addition to the list of bad loans. In case of our banking sector, most of its biggest defaulting borrowers, have been unable to service their mega debts for years on. In such a case, there is really very little to be gained from insolvency and bankruptcy proceedings. One will end up with peanuts, after having spent considerable time, money and resources in the process.
With all this said and done, it remains to be seen if the new additions are any good or just an investor sentiment pacifier, given the current context.
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