While, putting on hold its plans to implement the so-called “fresh-start process” for indebted poor people under the Insolvency and Bankruptcy Code (IBC) (it provides for debt waiver up to Rs 35,000 to the poor who don’t own houses, earn up to Rs 60,000 a year and have assets up to Rs 20,000 each), the government wants to first focus on bolstering the IBC architecture to yield quick resolution of toxic assets while preventing unscrupulous elements from gaming the system.
The reference here is to the delay in completion of the corporate insolvency resolution process (CIRP) as well as low amount realized by the creditors from their non-performing assets (NPAs) – a fancy nomenclature for loans that are difficult to recover or simply put bad loans. To get a sense of the situation on ground zero, let us capture a few basics.
Faced with ballooning NPAs (an asset quality review or AQR initiated by the Reserve Bank of India (RBI) in 2015 had led to identification of such loans aggregating to around Rs 1036,000 crore as on March 31, 2018), in 2016, Modi – government enacted the IBC. This legislation overrides all other subsisting laws and gives a strong handle to the banks for resolving NPAs within a strict time frame. In 2017, it amended the Banking Regulation Act (BRA) giving RBI powers to force banks to act if they don’t on their own.
On February 12, 2018, the RBI issued a circular that provided a foundational basis for resolving NPAs. As per this circular, for accounts with aggregate exposure greater than Rs 2,000 crore, as soon as there was a default in the account with any lender, all lenders – singly or jointly – shall initiate steps to cure the default by preparing and implementing a resolution plan (RP). This needed to be done within 180 days from the date of default.
In case, the lenders fail to be meet this deadline, they were required to refer the account to the National Company Law Tribunal (NCLT) which would initiate proceedings under the IBC. The NCLT would get 180 days to complete the resolution process. A further 90 days is allowed in exceptional circumstances. Thus, the outer limit for consummating the process is 270 days.
The raison d’être behind imposing this timeline and involving RBI to shepherd the exercise was to sell the NPA afflicted entity – as a going concern in an ‘objective’ and ‘transparent’ manner (to ensure this, firm’s control is vested in a Resolution Professional) and maximize the realization from sale.
But, we are far from achieving the intended result. Out of 1,723 firms, that were undergoing resolution until December 2021, around 73 percent had exceeded the 270-day limit, resulting in an erosion of stressed asset value. In fact, the recovery by financial creditors crashed to a record quarterly low of 13.4 percent of the admitted claims during October – December 2021. Furthermore, in 363 major cases, banks have taken hair-cut of 80 percent on an average (for some such as Videocon, it is even higher at 95 per cent).
Meanwhile, the NPAs position has not shown any significant improvement. According to a statement by the Minister of State for Finance, Bhagwat K Karad, in Parliament, NPAs of banks declined from Rs 1036,000 crore as on March 31, 2018, to Rs 834,000 crore on March 31, 2021. This excludes the Covid period – March 1, 2020 to March 24, 2021 – when banks were not allowed to recognize NPAs. On their inclusion, we may not see any improvement at all.
What explains the delays, woefully low yield from the resolution process and continuing high NPAs?
This has a lot to do with a revised RBI circular dated June 7, 2019 – issued in supersession of February 12, 2018 order – under directions of the Supreme Court (SC). It gives banks 180 days to come up with RP (in addition to 30 days to enter into an inter-lender agreement or ILA). If they do not, they are required to make an additional provision of 20 percent. If they don’t finalize the plan within 365 days, an additional 15 percent provision has to be made.
Unlike the February 12, 2018, which mandates the bank to refer the account to NCLT at the end of 180 days, under the revised circular, there is no such compulsion on it. Even if the RP is not ready within 365 days, all that it requires the bank is to make an additional provision of 35 percent (15 percent for first 180 days plus 20 percent for up to 365 days). With this, the bank will sit pretty complacent.
That the bank has no incentive to take it to NCLT, see it from another angle. If, RP is not implemented within one year from the default date, the bank has to make provision of 50 percent – 15 percent normal ageing provision and 35% additional. At the end of 15 months, with normal ageing provision increasing to 40 percent plus 35 percent additional provision , the total provisioning requirement will be a steep 75 percent.
Having adjusted a major chunk i.e. 75 percent of the loan amount in the profit & loss account, where is the incentive for the bank to recover the money by initiating proceedings under the IBC?
In short, by taking away powers from the RBI to navigate the NPA account for resolution under IBC, giving too much of leeway to the banks in preparing the RP and removing the compulsion on them to make reference to NCLT, the June 7, 2019 circular has rendered the IBC process dysfunctional.
Besides, there is a long list of interventions by the government as well as by the courts which mock at the resolution under IBC.
During the last five years or so, the government has infused Rs 300,000 crore in public sector banks (PSBs) to recoup the erosion in their capital (courtesy, NPAs). In the budget for 2021-22, it announced setting up of the National Asset Reconstruction Company Limited (NARCL) whose security receipts (SRs) will be backed by sovereign guarantee. NPAs worth Rs 200,000 crore will be handled through this route.
Other benevolences showered on banks and delinquent promoters are the so called pre-pack insolvency resolution (it envisages a direct agreement between secured creditors and the existing owners or outside investors, instead of a public bidding process); keeping the Central Bureau of Investigation (CBI) away from bank fraud cases unless it is an ‘extraordinary’ case such as IDBI Bank-Kingfisher Airlines.
When, such bail outs are given – either by direct funding from the budget or sovereign guarantee – or direct settlements allowed between lenders and defaulting promoter (read: pre-pack stuff) and stakeholders are shielded from the CBI, why would they come to the straight route offered by the IBC.
As for courts, in most cases involving large sums, they have been promptly entertaining appeals from the defaulting promoters and competing suitors (those whose bids get rejected) against award handed out by the NCLT. All of this has the inevitable effect of delaying the proceedings which hits at the very foundation of the IBC process – sharply eroding the realizable value.
Ironically, the constitutional validity of the IBC itself has been challenged. In this backdrop, any talk of bolstering the IBC architecture looks like a cruel joke.