Banking on Bankruptcy Law: The Global ANALYST, August 2017

Banking on Bankruptcy Law*: Breaking the Impasse

M G Warrier, Ex-GM, RBI

Credit is just one component of the resources deployed in industry/business and the prospects of the activity generating adequate surpluses to recoup the resources for growth and recycling depend on several factors, beyond the scope of credit monitoring. Indian financial sector is going through a transition and as the responsibility of other sectors for the chaotic situation gets identified and fixed, the health of Indian Economy will be restored and economic growth will not remain just a jugglery of numbers. If banking system has ‘stressed assets’, of a level higher than the tolerance limits, there are individuals and corporates who have gained in the bargain, who are making a last effort to get away by maligning the regulator and supervisor of banks. This time around, ‘WE THE PEOPLE’ are more vigilant and are watching the game closely.

The Insolvency and Bankruptcy Code (IBC)  passed  by the Parliament last year is yet another welcome move in the direction of strengthening the existing legal framework to deal with insolvency of corporates, individuals, partnerships and other entities. Currently, Government of India (GOI) is supporting Reserve bank of India (RBI) in guiding the banking system in using the piece of legislation (IBC) to handle the NPA Monster which has been growing in size and age taking advantage of a slow judicial system with several hierarchies and  bureaucratic hurdles. For the banking regulator and banks, the taming of this monster has become a ‘now or never’ challenge.

Closely following the passage of IBC by Parliament, the Global Credit Rating Agency Moody’s Investor Services had observed that “India's bankruptcy code boosts creditors bargaining power against big borrowers.”
Moody's also referred to significant infrastructure constraints to be crossed for the framework to be fully operational.
"The current weak legal framework for asset resolution has been a key structural credit weakness for Indian banks," Srikanth Vadlamani, vice president and senior

credit officer at Moody’s had observed, adding that “the proposed new rules address several key inefficiencies in the current resolution regime”.  

The background for a fresh legislation culminating with the passage of IBC was the ineffectiveness of the multiple overlapping laws and adjudicating forums dealing with financial failure and insolvency of companies in India. One of the fundamental features of the Code is that it allows creditors to assess the viability of a debtor as a business decision, and agree upon a plan for its revival or a speedy liquidation. The Code creates a new institutional framework, consisting of a regulator, insolvency professionals, information utilities and adjudicatory mechanisms, that will facilitate a formal and time bound insolvency resolution process and liquidation.

Equipped with IBC, Central Government constituted National Company Law Tribunal (NCLT) under the Companies Act which became functional from June 1, 2016. NCLT has one Principal Bench at New Delhi and Regional Branches at other ten major cities.

In mid-June, 2017, Reserve Bank of India identified 12 cases of high value bad loans for being fast-tracked at NCLT.  During July 2017, Essar Steel, one of the 12 industrial groups affected by this RBI guidance approached Gujarat High Court, arguing that the RBI decision was selective, arbitrary and discriminatory and obtained a stay order.

Hasty criticism

As is the practice, media and analysts developed stories quoting certain observations of the Gujarat High Court out of context and questioned the wisdom of RBI. Columnist Debashis Basu writing in Business Standard, referring to the context of the stay order, made the following observations:

Ø The supposedly bold action of the finance ministry and the RBI of going after the dirty dozen has turned out to be hasty, ill-considered, clumsy and legally questionable.

Ø Every High Court continues to have an open door to defaulters; the much-vaunted insolvency framework crafted by a bunch of legal luminaries and academics seems deeply flawed.

Ø It is only the first sign of how the new bad-loan resolution system will quickly sucked into a legal quicksand. There will be pile-up of cases and resolution will grind down to a snail’s pace, at least in case of larger accounts where speed is of essence.

Not clear whether the voice is of ‘hope’ or desperation or just a ‘curse’!

A different perception

I believe, this season, Centre and RBI are interested in moving forward in the direction of clearing the stressed assets mess in the banking sector by doing whatever is needed to overcome the initial hurdles they are facing. Action by regulators and governments will continue to be subject to judicial scrutiny and where there is a will, always there will be a way. One need not get disheartened by the view taken by Gujarat High Court over the RBI’s selection of top defaulters. Earlier also, GOI and statutory bodies in India have got over such issues by ‘following legally valid procedures’.

Just as opening several thousands of schools has not helped India become 100 per cent literate, the measures taken in 2014 onwards will not extinguish bad assets of the banking system that fast. Showering abuses at RBI or discrediting every initiative by GOI and regulators to put in place mechanisms to resolve a long pending problem will improve the readership of a column or a newspaper. But when a government and the central bank are jointly making some earnest efforts to meet the challenges which have arisen from decades of pampering of the rich and the powerful by a political system, efforts to divert attention from the main menu could easily get exposed.

It would be telling the obvious, if one observes that more bad loans are on the books of public sector banks. But business share of public sector banks also continues to be over 70 per cent. Has anybody bothered to know why private sector banks did not try to penetrate into more geographical space and aggressively improve their market share in banking business, post-nationalization of banks in India? Answer lies partly in the concluding observation recorded by Debashis Basu in the above piece: “Deep vested interests of academics, lawyers, bankers and accountants, who would like to feed off a clogged system as long as possible”. May be some from these categories have become rich and powerful and are  part of the ‘establishment’ today!

The stage for the present GOI-RBI initiative to go deeper into the problems arising from accumulation of unacceptably high levels of stressed bank assets and their concentration in large industrial groups was set with the assertion made by Dr Raghuram Rajan immediately after taking over as RBI governor in September 2013. He had observed then that ‘promoters do not have a divine right to stay in charge regardless of how badly they mismanage their companies’. Rajan was making the point that loan defaulters need to pay a price. Till then, the problem of NPAs was seen as an issue arising from inadequacies in credit decisions by banks or laxity in regulatory oversight.

Magnitude of the problem on hand

The 12 companies chosen by RBI for fast-tracking bankruptcy proceedings, roughly account for a quarter of the banking system’s non-performing assets, and naturally, are entities with large operations. Some banks/consortiums of lenders have acted on RBI’s guidance and action is in progress at NCLT. As mentioned earlier the way forward may not be without obstructions or protests as the Indian Legal System has several hierarchies and despite all honest intentions, the recalcitrant willful defaulters will not come around without trying all options available to frustrate banks’ efforts to recover dues from them.

Whatever be the final benefits to the economy, the follow up of action in respect of the 12 high value accounts will bring to public domain more details about the ‘give and take’ between corporates in the private sector and the banking system with tacit approval of the government and the establishment managed by political leadership. Many forget that in the entire economy, the only sector which is regulated and supervised on an ongoing basis is the financial sector, thanks to the existence of RBI with an institutional mind.

Essar Steel case

Out of the 12 high value NPA accounts being fast-tracked for bankruptcy proceedings by NCLT, let us take just one relating to Essar Steel. When the case first opened and Essar Steel got a stay from Gujarat High Court, media and analysts did not hide their sarcasm about the inefficiency of GOI and RBI. As the proceedings progress, it becomes clear that the rich and the powerful are never shy about hiding facts and using legal loopholes to delay the day of judgment. The claim made in the Gujarat High Court on July 13, 2017 by RBI jointly with SBI and Standard & Chartered Bank that Essar Steel was not revealing the correct picture of its journey to the bankruptcy proceedings and (Essar Steel) was presenting the facts selectively need to be seen in this context.

Essar Steel which has reportedly defaulted on more than Rs 40,000 crore of loans was also talking about an ‘offer’ it made in January 2017 to pay the loan amount ‘at the end of 25 years at 1% rate of interest. About this offer bankers pleaded ignorance!

The Gujarat High Court, on July 17, 2017 dismissed Essar's plea against NCLT proceedings.

When the Ahmedabad Bench of NCLT resumed hearing of the insolvency petitions filed by SBI and Standard & Chartered Bank on July 18, Essar Steel sought more time to file its objections. Partly conceding the petitioners' argument that the 'defaulter company' had had enough time for preparing objections over the previous fortnight when the issue was before the Gujarat High Court, the NCLT allowed the company time for filing objections only till July 22 and placed the next hearing for July 24, 2017.

RBI explains

In an interview given to Business Standard RBI deputy governor S S Mundra was asked about certain observations by Gujarat High Court like, “RBI is under the impression that now when jurisdiction of matters pertaining to company law has been transferred to NCLT by enacting IBC, the NCLT has to follow their advice and directions. This is a serious issue…” One feels that the institutional mind of India’s central bank is more graceful and mature when media, judiciary and a host of ‘victims’ affected by the performance of mandated role by RBI comes out in public, with what can be perceived as genuine criticism to scathing attack. S S Mundra’s response, ‘the wording was an ‘innocent oversight’ should satisfy those who are still up in arms against RBI.

It’s natural

Long monotonous arguments in the court rooms and a compulsion to write long judgments makes the bench occasionally stray away to make comments in ‘jest’ during hearings or include loosely hanging observations in decrees which are later quoted out of context by a sensation-hungry media or writers who want to make their columns interesting or spicy. Another such misquoted observation by the court was directed against the mechanism put in place by NCLT, which read ‘those with professional degrees may not necessarily be competent to run companies’. That again should be skipped as another ‘innocent oversight’ in expressing their Lordship’s views, as, when you point an accusing finger to an unidentifiable target, all other fingers go in the opposite direction!

Commonsense is law

It is reported that on July 23, 2017, Supreme Court, exercising special powers, allowed Nisus Financial and Investment Manager LLP (Creditor) and Lokhandwala Kataria Costructions (Borrower) to withdraw from the proceedings before NCLT when both jointly approached after arriving at a settlement where the borrower had made a part-payment. The amount involved was over Rs 40 crore. Apex court intervention became necessary as either party cannot withdraw once the insolvency proceedings get started under IBC. Though this may be a special case, one gets the comfort that, even today, commonsense is law and once convinced, courts won’t hesitate to come to the rescue.

Banking System: Built-in safeguards

Writing in The Moneylife (7-20, July 2017), R Balakrishnan made the following observations:

“One great thing the Reserve bank of India (RBI) has done somewhere in the past is to have a solidly high level of SLR/CRR (statutory liquidity ratio and cash reserve ratio). This gives a great cushion to the depositor. If the SLR/CRR were lower (currently the combined CRR/SLR is around 25%), the magnitude of lending would have been higher, and perhaps, NPAs would also have been higher. SLR are amounts measured as a percentage of deposit liabilities of a bank and are invested in government securities; CRR are a smaller percentage of these liabilities that is kept as a cash balance with RBI.”

This also explains the survival secrets of the Indian Banking System. When a bank is not able to maintain SLR/CRR at stipulated levels, the regulator gets the first signals of deteriorating health of that bank. If a bank has lent Rs75 (Net of CRR/SLR) out of Rs100 mobilized as deposits and 20 percent of the loans become NPAs, still 85 percent of its assets will be safe. The capital adequacy requirement is another cushion.

Role of Bank Credit

Credit is just one component of the resources deployed in industry/business and the prospects of the activity generating adequate surpluses to recoup the resources for growth and recycling depend on several factors, beyond the scope of credit monitoring.

Have a look at the regulatory and supervisory system that oversees the corporate sector. Just try to answer these simple questions:

·        Do we have a costs, prices and income policy for major industrial sectors?

·        Do we have a regulator or supervisor who tells us when funds borrowed/mobilized from public are diverted by a corporate entity for purposes different from those for which they were originally borrowed/mobilized?

·        What is the level of involvement of owners in running the companies?

·        To what extent corporates and political leadership are mutually dependent for survival?  Does such interdependence affect the policy formulation at government level and pricing and marketing at corporate level?

The purpose is not to embarrass by questions. The idea is to draw attention to the need to discipline private sector, by forcing them to accept the need for self-regulation, as the taxpayer and managers of public funds (GOI and RBI) have woken up and the blame game which held public sector banks responsible for all the ills in the economy is getting exposed.

Public Sector Banks were just conduits the establishment used to plough taxpayers’ savings into private sector which the rich and the powerful businessmen misappropriated using private companies as instruments. It is now for the authorities to track the flow of those funds and bring back whatever is retrievable. The Insolvency and Bankruptcy Code and the arrangements put in place under the legislation are steps in the right direction to achieve such objectives.

Transitional phase

Indian financial sector is going through a transition and as the responsibility of other sectors for the chaotic situation gets identified and fixed, the health of Indian Economy will be restored and economic growth will not remain just a jugglery of numbers.

If banking system has ‘stressed assets’ of a level higher than the tolerance limits, there are individuals and corporates who have gained in the bargain, who are making a last effort to get away by maligning the regulator and supervisor of banks. This time around, ‘WE THE PEOPLE’ are more vigilant and are watching the game closely.

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*This is an updated version of my article with the same caption published in the current (August 2017) issue of The Global ANALYST