India needs special rules to deal with failed airlines

India needs an ecosystem which allows airlines to have capital-light business models that don't require large upfront equity investments
India needs an ecosystem which allows airlines to have capital-light business models that don't require large upfront equity investments

Summary

  • The capital-intensive nature of the airline industry means banks must be allowed to play a more proactive role than they do in other sectors

SpiceJet is suffering collateral damage from Go First’s insolvency, with the National Company Law Tribunal’s order barring lessors of the bankrupt airline from repossessing its leased aircraft. As signs emerge of financial troubles at SpiceJet, lessors have pre-emptively moved to repossess their aircraft and filed applications to that end under the Irrevocable Deregistration and Export Request Authorisation (IDERA) framework, which obliges the Directorate General of Civil Aviation to deregister the aircraft in question in five days.

There are two mutually reinforcing ways to prevent such contagion spreading from one airline to another, relatively healthy one. One is for India to pass a bill, already in circulation for public comment, that would implement a 2001 treaty that India has signed, called the Convention on International Interests in Mobile Equipment or the Cape Town Treaty.

The clumsily named treaty does not concern mobile phones, of course, but planes, helicopters and the like. Once the bill becomes law, the Insolvency and Bankruptcy Code will not prevent lessors from repossessing their planes. Currently, the lessor is like any other vendor, whose rights are subordinate to the rights of a lender.

The other change required, which would have a bigger operational impact, is in a credit regime for the airline business. A niche must be carved out for the airline industry in which banks have a more proactive role than in other sectors and have special recourse.

The airline business, in which leasing the most capital-intensive part of the operation is the norm, calls for relatively little fixed investment, more working capital, and even more business savvy and efficiency in execution. The leasing of planes converts fixed capital into working capital. Instead of using lots of equity to cover the cost of acquiring aircraft, an airline company can borrow money to bridge the time gap between lease payments and the revenue it generates from operations. This also applies to the salaries of pilots, cabin crew, engineers, maintenance staff and ground crew, and to expenditure on branding, marketing, sales, aviation fuel, and airport charges.

To enable brisk growth of the civil aviation market that a fast-growing economy like India’s requires, it would be better to create an ecosystem that allows airlines to have capital-light business models that don't require large upfront equity investments. An airline can work on variable capital raised from banks. High debt-to-equity ratios make for high risk, and this high risk calls for special mitigation regimes.

This means that banks must have special credit norms for the airlines business as they bear the bulk of the financial risk, apart from those who lease aircraft to the airlines. They need different criteria to diagnose an airline loan as a non-performing asset from the standard ones for recognising bad loans. Falling to repay debt and interest on it for more than 90 days is the standard criterion for classifying a loan as non-performing. There is a case for shortening this period drastically. Should it be one month or 15 days? Banking regulators and the banks should work this out.

India’s digital financial infrastructure allows for more direct monitoring of a borrower’s business via the account aggregator system. Account aggregators operationalise the consent layer of the financial products enabled by Aadhaar and the India Stack collection of application programming interfaces meant to build on the Aadhaar infrastructure. Many banks and the GST Network are part of the account aggregator scheme. This allows any entity to collate its financial transaction data — sales and purchases, loans and credit, the servicing of loans and credit, GST paid and input tax credit availed of, other payments made and received — and share the snapshot with any entity of its choosing.

The account aggregator framework allows people to avoid being passive objects of data manipulation by third parties who would leverage their data to their own advantage. A small or medium enterprise can, for example, present its collated financial data to a number of potential lenders to get the most competitive loan terms. For lenders, the data compiled by the AA framework is far more relevant than the previous year’s audited financial statement for assessing the current operational health of the borrower.

There is no reason why an audit team under the risk officer of a bank lending to an airline company should not constantly monitor the financial data of the airline compiled by AA. This would allow the lender to sniff out early signs of trouble. Early detection and early cessation of operations would permit banks to minimise their exposure in the event of the airline’s collapse. This sort of discipline is required for working-capital-intensive businesses like airlines.

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