NPA resolution: well begun but half done
The Reserve Bank of India (RBI) has set the ball rolling for resolution of non-performing assets (NPAs) with the shortlisting of 12 big defaulters. These will now be processed further by the banks before being admitted by the National Company Law Tribunal (NCLT) for further processing of insolvency resolution as per the Insolvency and Bankruptcy Code, 2016. This is a step in the right direction. The 12 borrowers comprise a significant part of the NPAs in the banking system, and therefore need to be handled with the importance that these deserve. The pace and extent of resolution of these assets would also act as an important signal for the remaining NPAs as well as for future delinquencies.
So what is the next step in the process? The question being asked by most observers and faced by creditors is this: Will the current steps being taken by the government and the RBI, as per the insolvency resolution process, help in any meaningful recovery of dues? In order to answer this question, it is important to understand the next steps in the process. The creditors will need to appoint an insolvency professional (IP), and form a committee of creditors. This will be followed by negotiations between the stakeholders, primarily the creditors and the debtors, to arrive at a common approach for resolution within 180 days (extendable to 270 days). If the parties are not able to arrive at a solution, the borrower will be referred for liquidation. The liquidation will practically mean the auction of the assets of the borrower to pay off the dues to the creditors. Let us assume that the process moves smoothly till the stage of auction of the assets. This is a fairly uncertain assumption in view of the untested process and potential legal hurdles. Nevertheless, at this stage, the creditors need to move ahead and give their best shot, as per the process of insolvency resolution. It is interesting to note here that while in theory the auction of NPAs is supposed to be the last resort for resolving the issue, in practice it is expected to be the most likely option.
When the assets are put up for auction, bidders will be expected to bid for these. But then the big question still remains—who will buy these assets and at what prices? A defaulting asset, by definition, means that the equity has zero value. So, why should any buyer pay any money for such assets? These assets in the power, roads or steel sectors cannot be said to command any brand value or any such off balance sheet value. The negotiations have to focus therefore on how much of a haircut on the credit will be accepted by the creditors so as to make the transaction viable for the buyer of the asset. Based on the amount of haircut in the credit amount, the return on investments to be made for the buyer will need to be at a respectable level.
One side of the equation is simple to understand. The amount of haircut taken by the creditors will directly translate to an accurate measurement of losses for the creditors. But it is the other side of the equation which is prone to a wide range of outcomes based on the underlying range of assumptions and potential scenarios. The computation of the expected future cash flows on an Excel sheet is one thing and putting one’s cash to work, based on the highly uncertain assumptions, quite another. For instance, the view of the buyer will be influenced by the buyer’s views on the markets, policies, regulations, political scenario, to name just a few high-level factors. It is interesting to note that if one assesses the correlation (or even causality) of most of these risk factors with the intent or commitment of the government to resolve the issue, it should turn out to be quite high. The buyer will seek appropriate compensation for the expected potential losses as well as unexpected losses to arrive at a desired rate of return at a given level of certainty.
In other words, even as the process of insolvency resolution for the so-called flagship cases has been initiated, observers must be wondering how the elephant in the room has been consciously missed till now. And that is the explicit commitment from the government in terms of policy certainty, capital support (direct or indirect), and political will. Unless this aspect is addressed directly and squarely, we are likely to face the apathy of potential buyers when we get to the final lap of the resolution process. It is also understood that in an ideal scenario, the government should not be a part of the resolution process involving private parties. However, the current scenario is far from allowing a market-oriented solution. There are too many issues of concern emanating from government policies, imperfect or absent markets, contractual issues and macroeconomic pay-offs, and the same affect a robust price discovery of NPAs.
As they say, you can lead a horse to water, but cannot force it to drink. The initiation of the NPA resolution process has brought in a certain degree of rigour, but it still lacks the credibility to be called a bold or successful initiative. The banks are taking the required actions to the extent of their respective abilities and governing atmosphere. The RBI is doing its best, and even stepping into executive functions like scrutinizing NPA accounts and issuing directives to banks. However, the government has not yet stepped up to the requirements. It should evaluate the bottlenecks within its domain and bring in the appropriate enablers to help resolve the NPAs at the earliest.
Hemant Manuj is an associate professor of finance at SPJIMR.
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