A difficult journey… will finally start
The recent ordinance issued by the
government to amend the Banking Regulation Act 1949, empowers the Reserve Bank
of India (RBI) to assume a more decisive role towards a resolution of bad loans
that cripple the balance sheets of commercial banks and constrain their ability
to lend. The RBI can now effectively force banks to initiate measures on
stressed assets as well as invoke insolvency proceedings against irredeemable defaulters.
Moreover, it can advise banks on the resolution process, possibly even supervise
it, through special committees comprising of its representatives, those of lending
institutions and potentially outside experts. Bad loans within the banking
system amount to an appalling 9% of gross advances, the highest amongst major
emerging markets barring Russia. However, if all at-risk assets were to be
counted, the ratio jumps to a shocking 15% according to the Government of
India’s own Economic Survey 2016-17. Previous clean-up efforts have largely flopped
and the ratio of bad loans to gross lending has consistently risen over the
years. The Ordinance aims to reverse this trend.
The initiative is opportune for several
reasons. Despite recent legislative and regulatory changes intended to
strengthen the position of banks, little action has actually been taken against
defaulters. Many of these cases will entail large haircuts (a whopping 75% in
the case of the 57 biggest cases) in the form of distress sales and settlements.
Since such decisions involve a degree of subjectivity, bank officials worry about
being exposed to investigative scrutiny at a subsequent date. Moreover, a
written down balance sheet with consequential losses would reflect poorly on
the record of a CEO and, in a public sector career, he has little incentive to take
such a step. A third factor, applicable to large syndicated loans, is the
inability of consortium banks to agree on how, or even whether, to initiate
penal action against defaulters. The new Ordinance aims to alleviate some of these
problems by providing banks with the cover of an RBI mandate and an external
oversight committee to guide the resolution process. Some have argued that this
will merely shift the investigative glare from bank managers to the central
bank and committee officials. However, this would seem an unwarranted concern
as such individuals would be alien to the original transacting parties and in any
event are fulfilling regulatory obligations, not commercial ones.
A more legitimate concern is the fact that
the Ordinance effectively induces intervention by the central bank into the
affairs of banking corporations. Although it is meant to limit itself to the
issue of bad loan resolution, the fact is this issue is intrinsically linked to
basic management and operational practices within a bank. It is hard to say how
meddling the RBI will be or where it will draw a line between a curative role
versus an intrusive one. However, going by its history of progressive and
unobtrusive regulation, one might rightfully expect it to strike a judicious
balance.
On a more practical note, a major constraint
to the resolution of loan settlements lies just around the corner. This stems
from the hopelessly over-burdened and under-resourced judicial system that is
expected to arbitrate insolvency cases. The National Company Law Tribunal
(NCLT), created in 2016 under the new Companies Act, will not only adjudicate
on company law matters but also on cases under the Insolvency and Bankruptcy
Code. The Tribunal, moreover, is required to assume all pending proceedings
from the high courts, the erstwhile Company Law Tribunal (CLB), the Debt
Recovery Tribunal (DRT) and the Board for Industrial and Financial
Reconstruction (BIFR). According to a study by Alvarez & Marsal, a consulting
firm, this includes 4,000 cases from the CLB, 700 from the BIFR, 5,200 from various
high courts and 15,000 from DRTs – a total of almost 25,000 cases. To handle
all of this the NCLT has 11 benches and a grand total of 26 adjudicating
members. It is also short of administrative staff and assistants, which impairs
its ability to function. Alvarez & Marsal estimates that while an average
debt recovery judge in the US clears about 2,895 cases a year, his Indian
counterpart is able to manage just 360. At this rate, it will take the NCLT
seven years just to clear the backlog of pending and transferred cases, not
counting the additional burden that will soon be added when the Banking
Regulation Ordinance kicks in. On a positive note though, the Government
appears aware of the problem and is currently in the process of increasing the
NCLT’s strength.
In the final analysis, however, what really
matters is whether and to what extent commercial banks are willing to make an earnest
effort at debt resolution. The RBI can force them to initiate insolvency proceedings
and set up expert committees to guide them, but it is ultimately the banks that
have to implement measures and absorb losses. Subsequently, they will need to rebuild
their balance sheets through a recapitalisation process, which comes with an
entirely distinct set of challenges. A bank with a shrunken capital base can
hardly lend. Be that as it may, the ordinance is a decisive start and
demonstrative of the government’s effort to get to grips with the problem.
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