Bad loans & NPAs: The clean-up has begun!

26 Jul 17 Bad loans & NPAs: The clean-up has begun!

The Indian banking system is mired in distressed loans, currently pegged at over $150 billion. According to the RBI, gross non-performing advances (NPAs) of state-run banks – which provide a majority of all lending – stood at 9.6% in March this year. Insolvency and Bankruptcy Code Large borrowers accounted for 56% of advances and 86.5% of NPAs. The banks’ share in the flow of credit to the commercial sector, which was about 50% (of total flow of resources) a year ago, dropped sharply to 38% in 2016-17.

Historically, Indian banks have been reluctant to take legal action against defaulting companies. The World Bank’s Doing Business report provides a perspective – it takes an average of 4.3 years for creditors to secure a mere 26 cents on the dollar from an insolvent firm in India.

With a mountain of bad debts, how successful will India’s insolvency code be in stemming the problem?

The Insolvency and Bankruptcy Code 2016 came into effect in December last year to mark the start of a creditor in control regime. Contrary to what the name signifies, the main goal of the law is to make the defaulting company healthy again; liquidation is the last resort. The process must be completed within 180 days (extended by another 90 days if required) from the initiation date. If restructuring of the debt is not agreed within this time, the company will go into liquidation.

To initiate an insolvency resolution process against a corporate debtor, the creditor must file an application before the adjudicating authority viz. the National Company Law Tribunal (NCLT).

  • The NCLT will appoint an interim resolution professional who will manage the affairs of the corporate debtor. The powers of the board of directors are suspended.
  • A committee of creditors is formed who will, in their first meeting, appoint a resolution professional (they may appoint the interim resolution professional or replace him). They may also choose to appoint an insolvency professional.
  • The resolution professional will conduct the insolvency resolution process, and prepare an information memorandum.
  • The resolution plan must be approved by the committee of creditors, and then by the NCLT.

The cleaning up process has already begun. The RBI, which has been empowered by the government to initiate the insolvency resolution process, has identified 12 large defaulters. A majority of them are from the steel and infrastructure sectors. There are questions about how sound the process will be. Will the resolution professional be capable of running the defaulting company during the resolution process? Will the committee of creditors allow for cash flows to ensure that business will go on as usual? How co-operative will the management and promoters be with the resolution professional and committee of creditors?

The first signs of success will be evident when the 9-month deadline expires. To quote from a recent interview on CNBC-TV18 with Nikhil Shah, the Managing Director of Alvarez & Marsal – “The measurement if you ask me is what is the recovery that the creditors will achieve through this exercise? If they are able to achieve a 50-70% recovery on their exposure that could be viewed as a success for them.”

However, beyond the short-term, the success of this new law will ensure that it’s more difficult to take banks for a ride. Healthy bank balance sheets are essential if capital has to flow into industry and infrastructure. Thankfully, the recent determination shown by the government and the RBI to move the process ahead quickly is good news.

The resolution of bad debts is critical for the Indian economy – and the sooner the better!

Nandita Harendra
Nandita Harendra

I look after the corporate communications function at ValueNotes, and contribute towards marketing. You can reach me on nandita@valuenotes.co.in

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