The advantage of being a commentator is that one can be critical about everything without taking any responsibility. This holds for cricket, where the commentator may have never held the bat or could have been a very unsatisfactory one-day batsman, but may still talk eloquently and critically on the toss, let alone the game.This holds for cricket, where the commentator may have never held the bat or could have been a very unsatisfactory one-day batsman, but may still talk eloquently and critically on the toss, let alone the game.The advantage of being a commentator is that one can be critical about everything without taking any responsibility. This holds for cricket, where the commentator may have never held the bat or could have been a very unsatisfactory one-day batsman, but may still talk eloquently and critically on the toss, let alone the game. A similar principle holds for the Insolvency and Bankruptcy Code 2016 (IBC) resolution process where critics are quick to find fault in any measure taken, but also get worked up when nothing is done. Almost certainly, they provide no solution. The recent ordinance bars certain kind of promoters from bidding for their own assets which are being auctioned, though it allows them to join the fray if the dues are paid. It is not surprising that many have taken substantial volume of umbrage. Let us go back to the start.
Resolution of NPAs has always been difficult. After the asset quality review (AQR) was put in place, the NPA levels soared and reached almost 11-13% of impaired assets. This reflects poorly on our economic performance as there is an awkward feeling that, somewhere, we may have just inflated the economy by reckless lending, reminiscent of what China did when its the government supported an investment-led growth paradigm. The question is whether or not we swept the muck under the carpet, and have now gotten busy kicking the can to provide the camouflage that all is well.
The fact is that some large companies are not servicing their bank loans. Many an opportunity has been given for a solution—the Sarfaesi Act, corporate debt restructuring, the Scheme for Sustainable Structuring of Stressed Assets, strategic debt restructuring, etc, were all attempts to resolve the issue. But the tyranny of status quo prevailed. The public kept pointing out that these ruthless promoters were getting away at the expense of the taxpayers and deserved the strictest punishment. Bankers did not want to take a decision because there was a fear that any future investigation may conclude that the haircut taken was incorrect and a decision taken in vested interest. This would have the 3Cs (CBI, CVC and CAG) haunting them. The companies naturally wanted the maximum haircut, and hence, there was limited movement on NPA resolution. The final solution came in the form of the IBC which has set timelines for resolution and final sale of assets. The recent ordinance makes the system tighter by excluding defaulters from the game. This is when the story has developed a twist. A promoter who has not been paying his dues now decides to buy back the asset. Is it right? The public limited company is quite unique in structure as the promoter can control the company with limited stake and yet not be personally responsible for the NPAs. It is not surprising that these promoters often legitimately continue to live a life of luxury even when the enterprise cannot service its debt. In such a situation, should they be allowed to buy back their asset at a discounted price?
Such a point has been reached because no solution could be arrived at by the borrower and lender. But, it is only when the trigger—the exclusion clause—is being pulled that some promoters have taken offence. The law has now classified some categories of defaulters including wilful defaulters, NPAs for over one year, etc, that are to be excluded from the bidding process. Those who do not agree with this rule say that several such cases are due to extraneous factors that led to the normal course of business collapsing, and that if such action is taken, then risk-appetite will fall and investment will slide further down as investment hunger thins. There is some merit in this, but then no one had taken this stance when banks revealed that the NPA ratio was above 10%. Banks were accused of cronyism, pandering and incompetence.
Every major reform has some collateral damage. Demonetisation hit the household class quite perceptibly and the small and medium enterprises segment is still recovering from the backlash. GDP growth may have declined by at least 1% on this score. RERA has hit small real estate dealers hard—but they have to be clean now. GST has caused immense trouble for smaller players. IBC, if implemented in its current form over a wider spectrum of borrowers and loans, will also have such an impact.But such a cost would be worth it for cleaning the system. Further, as we have been crying hoarse for strict action, this ordinance provides a solution, albeit a moderately harsh one. In fact, when solutions were being suggested, there was support for naming and shaming defaulters as well as excluding them from further borrowing. The present dispensation only prohibits them from bidding for a mess created by them and, hence, is still quite moderate!
To make this exercise successful, some thoughts can be considered. First, while the law allows all NPAs to come under this umbrella, the committee of creditors (CoC) can be selective in taking decisions in conjunction with the Insolvency and Bankruptcy Board of India. Linkages could be built with the size and tenure of the NPA.
Second, valuation will always be a problem because a bidding process can lead to a sub-optimal price, leading to more controversy and even litigation. Strategic games played by bidders could push the price down. On the other hand, by allowing the promoter to bid, the system could be gamed with a higher bid being put in to reclaim the asset at a low price. So, we could have a ridiculous situation where a loan for, say, `100 is taken and not serviced. When the NCLT talks of selling the asset, the same promoter pays `40 and buys back the company or asset. The loss is, hence, still on the bank and the borrower has the last laugh. A minimum reserve price and auction should be the way out.
Third, the credit-default swaps (CDS) should now be used by borrowers and lenders for bank loans as well, as this will serve as an insurance cover. In fact, when a bond has to be issued in the market, a very good rating is required for investors to evince any interest. For bank loans, however, this is not the case. By insisting on a CDS, an enhancement can be made on the internal rating assigned.
There can be no debate that this is the right way out. Making it retrospective is a trifle harsh but sets a firm example that one cannot get away. Ideally, it should have been prospective, but doing so sends out the wrong signal, that the administration is weak. This creates a moral hazard—if the quantum of NPA is really high, then the system can never get harsh.
There will be genuine cases of companies affected by economic cycles. This is a cost to be borne, which will also get reflected in less risk-taking. We should be prepared for this. Also, one must remember that the industry is always against waiver of farm-loans where crises erupt mainly due to unfavourable weather. If this sounds reasonable, then the same should hold even for insolvency caused by external factors.
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