Don’t let the Insolvency and Bankruptcy Code go the CDR way

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January 02, 2021 6:30 AM

IBC should never have been kept in abeyance for so long and, if not handled well, the pre-pack can deal it a big blow

However, since the creditors and the debtors already arrive at a concensus on initiating the pre-pack resolution, chances of frivolous litigations under the proposed framework are minimised, analysts say.However, since the creditors and the debtors already arrive at a concensus on initiating the pre-pack resolution, chances of frivolous litigations under the proposed framework are minimised, analysts say.

Whatever its flaws, the Insolvency and Bankruptcy Code (IBC) is an excellent piece of legislation that has shown errant and willfully-defaulting promoters their place and given hapless bankers a better shot at recovering their money. It has restored the sanctity of the debt contract which had been all but eroded, promoters now know they can’t swindle the banks. While keeping the IBC in abeyance is never desirable, the government may have been somewhat justified in doing so for a short period; however, extending the suspension beyond six months was uncalled for.

The government is understood to be looking to tweak the IBC so as to also enable a financial restructuring of a stressed asset, as an initial solution, rather than an outright sale. From all accounts, the idea is to allow existing promoters to participate in a financial restructuring package if the loan exposure has been stressed for less than a year. In other words, lenders would give the promoters a chance to revive the business before declaring it insolvent and putting it through the corporate insolvency resolution process (CIRP). The idea has its merits; business cycles can be cruel and disrupt operations. Given the severe damage the pandemic has caused, promoters do deserve the chance to put their enterprises back on track. This is particularly true for mid-sized and smaller entities that don’t have the financial muscle of bigger corporations.

However, it is important lenders make sure this exercise doesn’t turn out to be another corporate debt restructuring (CDR). The CDR was the most ill-conceived mechanism of all time and cost the taxpayer thousands of crores of rupees. Banks were compelled to take hefty haircuts while promoters retained their businesses with most of them bringing in very little additional capital or none at all. At one point, the CDR cell had approved exposures of close to `4 lakh crore for a recast, not a small sum in those days.

But much of this money never came back, and banks were compelled to write it off. It wasn’t only small firms whose exposures were restructured; the list also included larger companies who could have brought in capital. To be sure, many companies were revived, but most of the cases admitted to the cell failed. Between April and October 2013, for instance, the number of successful cases was 45, but the number of cases withdrawn because they failed was twice that at 90. By the end of FY13, stressed assets—gross NPAs plus restructured assets—for the banking system were nudging 10%, and in the following year, they crossed that level.

The Indian banking system has a penchant for restructuring—CDR, SDR; the banks seem to prefer postponing problems rather than tackling them then and there. The pre-pack scheme can’t amount to kicking the can down the road. If the promoters are going to be allowed to retain their businesses as per the pre-pack scheme, they must bring in meaningful capital; capital could also be sourced from PE or other patient investors. A financial re-engineering in which the banks end up losing money can’t be allowed, the IBC has worked well even if delayed decisions have proved costly.

Ideally, the pre-pack scheme should be reserved for smaller borrowers; larger promoters should bring in capital to restore their balance sheets or risk losing their companies. It is amazing how the fear of losing one’s business can result in promoters suddenly finding the necessary capital.

Meanwhile, RBI on Tuesday cautioned loan losses at banks could rise from the 7.5% levels at the end of September; the central bank observed the share of special mention accounts—SMA-zero—saw a sharp rise in the September quarter, reflecting incipient signs of stress post the lifting of the moratorium. The stress in the SMA-1 and SMA-2 categories hasn’t been red-flagged. While some of these exposures too could go bad, there should be no cause for alarm if banks haven’t been underplaying the stress from the pandemic and if they have been setting aside enough capital to deal with toxic assets.

The talk about a bad bank, however, suggests the extent of loan losses could be bigger than was earlier anticipated. Economic affairs secretary Tarun Bajaj recently said that the government is exploring all options, including setting up of a bad bank, to improve the health of the country’s banking sector. Bajaj added the government would continue to recapitalise banks and had set aside the resources to do so. A bad bank is never a good idea because once the toxic assets are off the books, lenders tend to throw caution to the winds while borrowers feel they have been let off the hook.

It is better the government capitalises banks and lets each one fend for itself. The gross NPA ratio for the banking system fell from 9.1% in March 2019 to 8.2% in March 2020 and further to 7.5% in September, but, in all likelihood, this trajectory will reverse very soon. Much of the pain is expected in the MSME sector; despite the additional assistance given via the credit guarantee scheme, it is possible many of the businesses will not survive. Banks must take the hit and move on.

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