Finance minister Arun Jaitley announcing that RBI is at a fairly advanced stage of preparing a list of debtors where a resolution is required through the Insolvency and Bankruptcy Code (IBC) is good news. According to Jaitley, a total of 81 cases have been filed under IBC—though he has not given details of the amounts involved, the fact that only 18 of these were filed by banks suggests they remain reluctant to go for insolvency proceedings, given how this will affect their balance-sheets. Ideally, as this newspaper has argued before, the capital-infusion cycle has to broadly be similar to the bad-loan-recognition one, else it will affect the PSU banks’ capacity to lend. The government’s ability to infuse capital, though, is a small fraction of what is required and will lead to stealth privatisation. Bank consolidation looks like a good idea, but merging weaker banks with stronger one will only make the combined entity weaker, one which can’t raise equity easily.
What is interesting, in this context, is a recent analysis by IdeasForIndia, an economics and policy portal with an illustrious lineage. The researchers study a panel of 114 stressed accounts between 2008 and 2012 in order to see how they fared under the central bank’s Corporate Debt Restructuring (CDR) scheme—it looks at a two-year period prior to the CDR and compares this with the two-year-after period. What it found was that more than 80% of firms that were relatively healthy or were facing mild distress moved to ‘distressed’ and ‘highly distressed’ in the T+2 period. Only three of 16 firms in the ‘distressed’ and ‘highly distressed’ categories found their health improving in the T+2 period.
What IdeasForIndia found was that banks continued to lend despite the stress levels of firms rising. While many, in banks as well as government, argue that financial performance of firms will get better as the economy looks up—this was one justification for continued lending—in Q2FY17, Credit Suisse data showed that while aggregate ebitda rose 9% on a y-o-y basis, it contracted 24% for firms with an interest cover of less than one; that is, financially weak firms generally tend to be those that are also badly run. Given that the CDR process also allowed banks to stagger the process of loans becoming NPAs, they had another incentive to prefer this. That is why, when banks are now examining what proportion of debt is sustainable—as part of the restructuring process of loans—it is critical that this be done very carefully and, as far as possible, banks be encouraged to take a larger write-down since that will increase the chances of the firm doing better. But, in a large number of cases, it is possible no resolution will at all help, and so insolvency is the best option.