IBC is the need of the hour for the Indian NPAs mess?

• The state of NPAs in India
• Introduction of IBC and other measures taken in the country
• What happened till date?

Non-performing assets (NPAs) or bad loans arises when banks make a poor lending decision or wherein loans were given after due consideration, though macroeconomic conditions, sector-wise changes or company-wise issues develop at a later stage and lead to a conversion of loans into NPAs. In the current era, NPAs have become a major challenge for both the public and private sector banks in India. Among the major economies of the world, Indian banks have the second highest ratio of NPAs after Italy (Source: IMF). In the exuberant economy sphere, which started around 2005 and continued until the global financial crisis of 2008, large corporations conceived major projects in the capital-intensive sectors such as highway construction, power, ports, airports and housing. This was supported by funding from banks as a keen lender amid reckoning of a big opportunity with a huge consumer market. However, due to the global financial crisis these large projects either remained work in progress or even if completed remained underutilised. In the absence of originally anticipated cash flows over an extended period of time, bank loans turned sour and thereby, triggered significant NPAs build up. The NPAs of Indian banks have mounted to INR 10,360 bn as on 31^st March 2018, representing an 11.6% of the total advances given by these banks. In the fiscal year 2017-18 alone, the bad loan pileup wiped out ~INR 2,500 bn for the banking industry. Interestingly, NPAs ratio was just ~2.5% at the start of the decade (2009-10). In FY 2015-16, the RBI (Reserve Bank of India) initiated Assets Quality Review (AQR) and tightened the norms for NPAs recognition and due to this, banks had to recognise some assets as NPAs, which otherwise were considered as standard assets through ‘evergreening’ in the banking parlance. Though the steps taken by the RBI resulted in a recognition of a true asset quality for banks, NPAs have become a bigger concern at the level of the economy.

The data from RBI shows that the Public Sector Banks (PSBs) have the largest share of NPAs in the Indian banking system with ~15.6% gross NPAs ratio as compared to just 4.0% and 3.8% in the case of the Private Sector Banks (PVBs) and Foreign Banks (FBs), respectively. Further, as a result of the transparent recognition of stressed assets as NPAs imposed by the RBI, the gross NPAs of PSBs have increased from ~INR 2785 bn in FY 2014-15 to ~INR 8956 bn as on 31^st March 2018, which is most among all the Scheduled Commercial Banks (SCBs). The State Bank of India (SBI), which is an industry leader, has the highest NPAs in the country and has logged ~INR 2,230 bn as NPAs as on 31^st March 2018, which is up by ~INR 450 bn from the last year. Similarly, issues like Nirav Modi scam, the Rotomac bank fraud, Winsome Diamond scam has hit many private and public sector banks, which further inflicted the NPAs problem.

Moreover, Financial Stability Report of the RBI reveals that within the industry, the stress advance ratio (Gross NPAs + restructured standard advances) to sectors such as basic metals, paper industry, gems and jewellery and cement industry are at a high level. The construction, infrastructure and automobile industries also account for a sizeable chunk of the Indian banks stress advances and NPAs. The basic metal industry is most indebted with 46.3% stress advances out of the total advances given by banks as on 31^st March 2018.

Hence, several measures have been taken by the RBI and the Government of India over the years to recover NPAs and bad loans from wilful defaulters both through the legal and financial and policy level reforms. But most of these did not provide the desired results or had a moderate to low success due to certain limitations both at the mechanism and execution levels. Thus, there was a dire need to address these growing NPAs in the Indian economy.

In 2016, the Insolvency and Bankruptcy Code (IBC) was enacted by the government to streamline the corporate insolvency resolution process, facilitate the restructuring and systematic resolution of distressed businesses, yet it preserved distressed but viable businesses. The IBC brought a paradigm shift in the recovery and resolution process by aiming the ‘Time’ and ‘Cash’ element, which was somehow missing in previous regimes and provides cash flow approach (as application for CIRP [corporate insolvency resolution process] can be filed on payment default in respect to the debt of one lakh rupee or more rather than on the erosion of net worth) within a time-bound process for debt recovery. This is also focused on the concept of ‘creditor in control’ instead of ‘debtor in possession’ by giving powers to ‘the creditors’ rather to ‘the court’. Further, to align the resolution mechanism, the RBI has withdrawn its earlier regimes and kept one law for bankruptcy in the country, the IBC. Under the IBC, bankruptcy has to be resolved within the prescribed 180 days (or extended 270 days) failing which the assets have to be liquidated and thus, provide no deadlocks. The government is also committed to constant improvements of the process under the IBC and brought amendments to the code for plugin of loopholes, while preserving the core purpose like treating homebuyer at par with financial creditors so that they can also take builders to bankruptcy courts, for easy decision making to decide liquidation or resolution plan – voting threshold was brought down to 66% from earlier 75%. This gave relief to MSMEs by providing power to promoters on a bid for their enterprises and enabled pure play financial institutions such as Asset Reconstruction Companies (ARCs), foreign institutional investors, venture capital funds, which may be related to defaulter to bid for distressed assets in NCLT (National Company Law Tribunal).

The IBC essentially advocated a more direct path for the handling of bad loans as it gives power to lenders to trigger off bankruptcy proceedings against defaulting borrowers. The defaulter’s assets would be put up for sale if a buyer was found, lenders could decide whether to take up the offer or liquidate the defaulter.

The RBI has also taken other steps to deal with NPAs. Firstly, a list of the 12 biggest corporate defaulters called ‘Dirty Dozen’ was released to put these for bankruptcy resolution on an immediate basis. A list of another potential 28 companies was also released that will undergo insolvency proceedings. The RBI placed 11 public sector banks (PSBs) out of a total of 21 PSBs on its prompt corrective action (PCA) list. Further, after the ‘Indradhanush Plan’ in 2015, which was aimed for infusion of a capital of ~INR 700 bn in PSBs, the government again unveiled re-capitalisation plan this year for the PSBs that include capital infusion of ~INR 800 bn through recap bonds and ~INR 81 bn through budgetary support to address regulatory capital requirement of all PSBs and provides support towards growth capital for increasing of lending in the economy. The government announced ‘Project Sashakt’ in 2018, with a focus on asset turnaround to ensure job creation and protection by providing a resolution to bad loans depending on its size. However, this has been criticised over deferring the inevitable, rather than resolving the NPAs mess as IBC has already covered some of the suggestions and the AMC (Asset Management Company) route will only give additional time to defaulters before taking action for their bankruptcy.

Additionally, the RBI announced a complete overhaul of the asset resolution process in February 2018 and set a strict timeline and criteria for reporting and resolving NPAs to facilitate IBC. Under the revised framework, lenders will identify early stressed loans by classifying them in SMA (Special Mentioned Account) categories (SMA 0 – amount overdue between 1-30 days, SMA 1 – amount overdue between 31-60 days and SMA 2 – amount overdue between 61-90 days) and report SMA status and default to the Central Repository of Information (CRILC) for large credits (INR 50 mn or more) on a weekly basis. Furthermore, in case of a large loan exposure of INR 20 bn or above, insolvency proceedings would have to be initiated under the IBC within 15 days if a resolution plan is not implemented within 180 days of the default. The central bank brings penalty and higher provisions if a bank tries to conceal stress assets now and failed to comply with guidelines. According to RBI’s instruction, ‘Wilful’ defaulters are not sanctioned any additional facilities by banks or financial institutions, their unit is debarred from floating new ventures for five years and lenders may initiate criminal proceedings, wherever necessary.

However, all these measures have yet not proven to be quick and effective as envisioned by the government. Only two have found buyers out of the 12 big cases, while hundreds of small cases which were referred under the IBC have found few or no buyers. According to the data released by IBBI (Insolvency and Bankruptcy Board of India), only 34 cases out of 977 companies admitted under CIRP saw successful resolution and 136 cases have been ordered for liquidation at the end of June 2018. Around 186 cases have crossed 270-day limit and, in some cases, banks had to write off almost everything that was lent. One of the problems is that banks are unwilling to take haircuts when selling debt to ARCs. For stressed assets or bad loan, it has to be at an attractive price or cheap enough for a buyer otherwise banks need to take a haircut. This is critical because the recovery rates in India have been very low at 15-20%. Average 45% haircut has been estimated for creditors in those 12 cases referred to the RBI. Another reason is the capacity constraints as inadequate resources are available to tackle bad loans and bankruptcy cases. India only has 11 NCTL to handle not only bankruptcy cases, but also other cases like mergers and disputes under the companies act. While RBI named 28 more large NPAs cases, NCLTs have admitted only 14 till date. After the introduction of new guidelines in February 2018, larger NPAs cases are expected to be referred to the NCTL, including 40 comatose power projects as the RBI has refused to relax the new framework to resolve bad loans related to the power sector. In addition, RBI is also not ready to relax norms for setting up an ARC for warehousing stressed projects to prevent distress sale. According to a report of the Parliamentary Standing Committee, about 66 GW of conventional energy projects are under various degrees of financial stress, which include 54,805 MW of coal-based power (44 assets), 6,831 MW of gas-based (9 assets) and 4,571 MW of Hydro (13 assets) in addition to certain cases that already has been referred under the CIRP.

The ballooning NPAs are nagging the banking industry and Indian bank’s stressed assets currently stand at 9.6% of the GDP or about half of the 2018 Budget. The government and the central bank are continuously taking the necessary steps to curb and curtail the mounting bad loans. There are certainly hindrance and timeframes have often been breached as the nascent law IBC is evolving its jurisprudence. But in the long run, IBC, Project Sashakt and other frameworks are expected to bring in structural changes. The recent announcement to increase NCLTs from 11 to 24 and a simultaneous increase of benches to clear pending cases gives further hope. While lending, all these steps will create a sense of prudence in the banking system and at the same time a sense of control to creditors and fear of losing power by stakeholders that could prompt a timely resolution of their dues.