IBC may end NPAs problem, but won't help banks get their money back

IBC may end NPAs problem, but won't help banks get their money back

For the big 12 debtors that the banks referred to the NCLT at the Reserve Bank of India's (RBI) behest, there is still a fair amount of interest from bidders.

As the 400 plus cases under the IBC at the NCLT wind their way through the various stages of the resolution process, banks are increasingly coming to the conclusion that they are in a no-win situation. For the big 12 debtors that the banks referred to the NCLT at the Reserve Bank of India's (RBI) behest, there is still a fair amount of interest from bidders. But all the bidders expect the lenders (the banks) to take massive haircuts - at least 50 per cent, if not more. Some are hoping the banks will take 70 or 80 per cent haircuts in order to get the deals done. The potential buyers are shopping for bargains. They are not interested in paying a rupee more than they need to.

For the banks, taking big haircuts is galling. The moment a case is referred to the NCLT under the IBC, banks have to make a 50 per cent provision for loans in their profit and loss accounts. If it goes into liquidation, banks have to make a 100 per cent provision for the loan. If the resolution process results in a sale which makes enough money for the bank - at least if the amount is more than they have provisioned - it goes into the profit column of the lender since the provisioning has already been made. On the other hand, if the resolution fails, the bank will have to write off the loan.
As it turns out, reports suggest that there is practically no interest from buyers for most of the small and medium sized companies that are under the IBC process. In most of the smaller companies, only the promoters are interested but the new ordinance which the government brought out practically bars all promoters from bidding for their own companies unless they first settle the NPA. Few promoters can organize the money required to do so... and if they do manage, then they are probably arranging the finances at an even higher cost than what they originally borrowed at, and therefore the company is getting into even more trouble. (This is assuming the company became an NPA for genuine business reasons and the promoter had not siphoned off the funds and is in a position to bring his own money which he had taken out).

For the banks therefore, it is being caught between the devil and the deep sea. If they do get a buyer for the asset, they will probably have to take an enormous haircut. (In the first case that was resolved, the banks took a 90 per cent haircut on principal and interest, though it came down if only principal were considered). If they don't find a buyer, the property goes into liquidation and again banks end up losing almost all the money they lent. Thus while the IBC provides a good way of cleaning up the mess of companies that were in serious trouble, and it will also finally end the amount of NPAs in the bank's books, it doesn't help the banks get back much of the money that was lent out.

This is also why reports suggest that the bankers want the debt resolution deadline of the 28 companies that were to be sorted out by December 13 to be extended. As things stand, these were the second list of companies the RBI had given banks to resolve the debt problems by December 13 or be sent to the NCLT for insolvency proceedings. For the lenders, these are not the biggest companies and probably not the most prized assets so finding buyers for them would probably be more difficult than it is likely to be for the first big 12 cases. Moreover, until the first set of dozen cases are resolved successfully, the bankers do not have a template as to how much haircut they are likely to end up taking. They would prefer to continue their debt resolution talks with the promoters of these 28 firms rather than take them to the NCLT under the IBC.

It was not supposed to be this way. In the original scheme of things, the IBC was supposed to sort out in a fixed time the problems the banks had encountered with previous schemes to resolve the NPA mess. The Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act 2002 (Sarfaesi Act) allowed secured lenders to take over the management of the company and helped in the creation of Asset Reconstruction Companies (ARCs). However, the Act was less than helpful in actually recovering money. It ran into all sorts of practical problems.

The Corporate Debt Resolution (CDR) mechanism which was tried out in between was helpful only in case the borrower was genuinely interested in paying back the loan he or she had defaulted on. The CDR mechanism essentially helped give the borrower a longer time period to pay up, and this was okay for honest businessmen. But too many CDR cases did not help the banks because the companies continued to be sick and in default despite the concessions and the banks still had a problem in their books.

The Strategic Debt Restructuring (SDR) and the Scheme for Sustainable Structuring of Stressed Assets (S4A) again allowed banks to convert part of their debt into equity and become owners of the companies and then try and sell them off. But again, the problem cropped up largely because taking over a company was so much easier than actually running it or finding a buyer, especially in a bad economy.

In the case of the IBC, the biggest advantage is that as the resolution follows a very clear cut process, and timelines, and because it has an insolvency professional guiding the mechanism, the bank management will not be blamed even if things do not work out. (In other schemes, they could always be accused to colluding with managements to take a haircut, ever green the loans or any other malafide practice). But beyond that, there is little comfort when it comes to getting money back.

The greatest strength of the IBC - it sets a specific time limit and the process cannot go beyond 270 days - is also a weakness because it allows potential buyers to play the game of Chicken with banks. They know that if it is not resolved, the case will go into liquidation and the banks will take an even worse loss - and therefore the potential buyer can afford to quote a low price in the expectation that the banks will have no other option but to accept. It would only help the banks if there are multiple bidders vying to take over a very viable asset - but those would be the few cases, not the majority.

The lesson from this for banks is that in future they need to be far more careful and do far more due diligence when giving out loans. Because taking a company to the IBC is unlikely to help them recover their money.