3 min read.Updated: 15 Jan 2016, 08:26 AM ISTKunal Kundu
Reforms in bankruptcy laws can play a crucial role in economic growth and financial stability
The Reserve Bank of India (RBI) started a process whereby all new restructured loans are classified as bad loans. A restructured loan is one for which the borrower has renegotiated the terms of repayment, while a bad loan is where the borrower has not made payments for a certain period and there is risk of default. Effective 1 April 2015, all restructured loans have to be classified as non-performing assets (NPAs), with provisioning of 15% of the outstanding versus the earlier requirement of 5% for restructured loans.
The idea is to disincentivise banks from opting to restructure loans on the slightest pretext to prevent them from qualifying as NPAs. The new rule is expected to force banks to recall loans, take early recovery action or sell NPAs to asset restructuring companies. However, after the new provisioning norms were introduced, no new case was referred for restructuring in either the June or September quarter. This is a surprise given that the weak economic conditions have not improved materially. While it is difficult to arrive at a meaningful conclusion, there is a sense that there could be under-reporting to prevent bloating of NPA levels.
In India, a loan turns into an NPA if interest repayments remain due on the 91st day. Of late, there has been a sharp spurt in loans for which repayment is due for more than 60 days. These are termed Special Mention Accounts-2 (SMA-2). Anecdotal evidence suggests that the amount of loans that are on the verge of turning bad has risen substantially. But it’s difficult to get an exact sense as RBI doesn’t require banks to publicly report this data.
Available evidence suggests that India’s NPA situation is likely to worsen further before it starts to improve. While the economy has bottomed out, the process of recovery will be slow. With a more proactive RBI now, the situation is likely to improve. Banks have started to convert their loans to equity, especially of the wilful defaulters. The key to success of this programme lies in the banks’ ability to dispose the newly acquired businesses within a reasonable time-frame, failing which they would be saddled with businesses that they don’t have the management competency to run.
While economic growth remains the immediate solution to this problem, India is in desperate need of an appropriate bankruptcy law to help tackle the NPA problem in a more meaningful way.
India’s existing corporate insolvency resolution framework fares poorly in terms of both timeliness and cost of proceedings. Problem is, longer the time taken, greater is the probability of erosion in realisable value of assets and, hence, lower the recovery rate. Not surprisingly, despite a one place improvement in ranking in terms of resolving insolvencies (within the Doing Business Index of the World Bank), India still ranks a poor 136 out of 189 countries and the last among the BRICS countries (Brazil, Russia, India, China and South Africa). The average time taken for insolvency proceedings in India (according to the report) is about 4.3 years, while it is only 1.7 years in the high-income member countries of the Organisation for Economic Co-operation and Development. More importantly, lenders tend to recover just about 20% of their loans when businesses go bust compared to the over 70% recovery in developed countries.
Reforms in bankruptcy laws can play a crucial role in economic growth and financial stability. An effective insolvency framework can offer huge economic benefits like ensuring maximisation of value of creditor’s claim by rehabilitating the ailing debtor company or through an effective liquidation framework if rehabilitation is not achievable. Absence of a rational and efficient process of corporate insolvency has inhibited development of a vibrant corporate bond market. Large amounts of capital and assets have been locked up in enterprises that have gone under with little prospect of revival.
Unfortunately, at this point in time, there is no comprehensive and integrated policy on corporate bankruptcy in India. Multiple agencies are involved in the process, whose jurisdictions often overlap. This can create systemic delays and complexities. Keeping this in mind, the Bankruptcy Law Reform Committee (BLRC) was set up, which submitted the draft of its proposed Insolvency and Bankruptcy Code. Among other issues, this draft addresses the timeline issue by stipulating a strict timeline of 180 days for insolvency resolution and limiting judicial determination at the trigger stage and thereby help de-clogging of judicial bandwidth. Also, even operational creditors such as employees and utilities with dues can initiate insolvency proceedings when the borrower defaults.
If the government is successful in passing the relevant bill, this will not only be a big confidence booster for investors, but India’s ranking in the Doing Business Index will see a big improvement.
Kunal Kundu, India Economist, Societe Generale Global Solution Centre Pvt. Ltd.