The saga of the financial crisis continues to spill over into the manufacturing sector with GM now filing for bankruptcy under Chapter 11. The question is, what are the lessons for us in India?
Bankruptcy laws in India remain weak. Within the set of Asian nations, it was found that India, along with Indonesia, has the lowest rates of recovery and also takes the longest time for settlement. For example, in countries like Australia, Japan, Hong Kong and Singapore, such cases are sorted out within a year while the recovery rate is as high as 80-90%. In contrast, in India, the recovery rate is just 10% while it takes an average seven years for a settlement with some cases stretching beyond ten years.
The main problem relating to bankruptcy is recognition. There is quite a stigma attached to bankruptcy and companies are not willing to accept the same. Further, once recognised, companies are not willing to have a change in management unless it is absolutely essential. Also, the rehabilitation packages invariably involve reduction of costs, which includes labour, where the laws are rigid.
The banking system is most affected by rising potential delinquencies due to the large amounts of capital that are held up on this score, with NPAs being a manifestation of this phenomenon. The Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 (SARFAESI) empowers banks to recover their non-performing assets without the intervention of the court and this is done through securitisation, asset reconstruction companies and enforcement of security. However, there are issues here relating to the smaller units being targeted by banks. The Act views all defaulters alike without any distinction as between a wilful defaulter and a defaulter by circumstances beyond his control.
There is really a dilemma here as debtors tend to delay and prolong the process of reconciliation. Often debt is enhanced further in the name of reviving the unit or attempts are made at ever-greening. Further, political pressure could be applied to ensure that the enterprise continues operations without any interference.
Clearly, there is need to strengthen this process through better monitoring and redress. Firstly, banks need to strengthen their appraisal processes to ensure that more due diligence is done at the time of loan delivery. Secondly, it is essential to draw up early warning signals through regular follow up with the clients and have systems in place. Declining profits, erosion of net worth, adverse industry conditions, erratic management decisions, absence of planning, etc could be the signs that one should look out for. The statement of accounts of the companies need to be monitored with alacrity to pick up such signals. Thirdly, once a company has been recognised as being vulnerable, it should be advised to go in for the rehabilitation route wherein creditors should have the prerogative to choose the management and ensure that it is back on rails. The final option would be to actually sell out the unit and distribute the proceeds according to the hierarchy as laid down by the courts. While this is a solution, there would be a loss incurred by the banks in that they would have to write off assets and book the same in their books.
Simultaneously, the legal processes must be made more creditor-friendly so that the cases are not prolonged. The pertinent Acts need to be harmonised and consolidated so that the approach is singular. The laws have to be strengthened to ensure that revival packages do not create a new moral hazard where companies fail knowing full well that they will be bailed out by the financial institutions or the government. We have had cases in the past, where the government has stepped in and had the banks rescue other entities.
A balance has to be struck hence between closure and sale and rehabilitation of the company so that the ?largest good? is secured. Besides, the judicial processes should be sped up. This will also make banks more proactive towards borrowers during difficult times and not ultraconservative, which is the case today.
?The author is chief economist of NCDEX Ltd. These are his personal views