Bankers wary of insolvency code as high provisioning looms

Earlier, the general perception among bankers and even policy makers at RBI was that the absence of a strong bankruptcy code was behind the many ills in the banking system

When the Insolvency and Bankruptcy Code (IBC) was introduced in Parliament in December 2015, bankers were jubilant that they could finally show some tough love to the borrowers gaming the system. But in less than a year since the Code became effective in December 2016, banks seem to have lost interest in the new framework.
 
Earlier, the general perception among bankers and even policy makers at the Reserve Bank of India (RBI) was that the absence of a strong bankruptcy code was behind the many ills in the banking system. The banking regulator had been rolling out one scheme after another, but out of design, or perhaps perversely, bankers used them to sweep their bad debt dirt under the carpet.
 
Rightfully, then RBI governor Raghuram Rajan launched a diatribe against the banks and proposed a deep surgery in the form of asset quality review. The idea was to bring out all the bad debt on the bank books. And then, those bad debts were supposed to get cleaned up by the Bankruptcy Code.
 
On the face of it, the process seemed pretty straightforward. Banks needed to refer a company to the National Company Law Tribunal (NCLT), which then would appoint an insolvency professional who would act as the CEO of the company. And in six months, the debt-laden company would either be nursed back to health, or liquidated and creditors be paid off.
 
Bankers now are sort of pleading to the central bank that they don’t want to invoke the Code to all companies.
 

The first case that saw a resolution under the Code is of Synergies Dooray, in which the National Company Law Tribunal (NCLT) ruled in favour of a 95 per cent haircut and the backdoor entry of promoters. This has clearly spooked the banks. While this kind of haircut may not repeat, bankers say haircuts could be as large as 75 per cent in many cases; the average will have to be 50-60 per cent of loans.
 
On top of this, the RBI has mandated banks to provide 50 per cent provision if a case is referred to the NCLT and 100 per cent if liquidation order is set. In most cases, banks have set aside about 30-35 per cent provision.   
 
According to rating agency Crisil, banks would need to set aside close to Rs 3.3 lakh crore this financial year, or 50 per cent more than the Rs 2.2 lakh crore they provided for last year.
 
“Potential write-downs could be in the 25 per cent to 75 per cent range,” Crisil said, adding, while some of the NPA (non-performing asset) accounts had been adequately provided for, the majority of them would require higher provisioning compared with current levels, based on the residual economic value of the assets.   
 
“Crisil estimates this could lead to a net loss of Rs  60,000 crore for the banking sector this fiscal, with public sector banks bearing the brunt of increase in provisions and the resultant impact on profitability because of their higher stock of NPAs,” it said.
 
At the end of March 2017, the gross NPA of the banking sector reached 9.6 per cent of their advances.
 
Concern of bankers
 
Now faced with a huge burden to set aside money for bad loans and shortage of capital, commercial banks want the RBI to relax provisioning norms and the government to articulate a clear plan for enhancing capital infusion amount for public sector banks.
 
“There is no clear plan in place on capital infusion. When banks’ interest income is falling and profitability is stressed, setting aside more provision may not be possible,” said a senior public sector banker.
 
The provision obligation for the first batch of 12 cases referred for insolvency in June is manageable. Banks have been making provision for these companies for many quarters now. But there will be severe pressure on balance sheets when they have to decide on cases from the second batch. The worry is to find that much money when inflows from interest income are weak.
 
Senior public sector executive said banks were talking with the banking regulator through industry lobby group Indian Banks’ Association (IBA) about issues. “It heard us but was steadfast on the requirement of provisions,” said a banker.
 
Insolvency professionals are new to the entire process of dealing with bankruptcy courts, and in many cases they are grappling with complications. “If 28 more such large cases move to the NCLT, that would only add to pressure without any benefit in sight,” said another banker. 
 
Besides, bankers say, a tendency of operational creditors dragging corporate debtors for defaults with small amount is taking time at the forum. Rules and practices are still evolving as these being early days for the bankruptcy regime.
 
Banks are also not able to invoke personal guarantees till a resolution of cases is concluded. This, bankers say, takes away the case for referring a company to the NCLT before recovering as much due as possible. In many cases, where promoters have given personal guarantees for loans, banks have a clear disincentive to head for insolvency proceedings.
 
The IBC is also being used by debtors, complicating matters for the creditors. Analysing 110 cases filed in the NCLT in the first six months of the Code, a research paper by Indira Gandhi Institute of Development Research (IGIDR), Mumbai, found that while 75 per cent of the cases were filed by creditors, corporate debtors filed the rest 25 per cent.
 
The paper also said “the working of the NCLT is not always in line with the letter and spirit of the IBC,” as the tribunal seemed to be viewing the admission of an insolvency case as an excessively harsh outcome for a debtor.
 
“For those cases where the data is available, we find that the NCLT took an average of 24 days to dispose of a case, compared to 14 days that are visualised by the IBC. Finally, while the law sets out very specific grounds for dismissing an insolvency case and is largely biased towards allowing an insolvency to be triggered if the debtor has committed a default in repayment of an undisputed debt, the NCLT has also dismissed petitions on considerations not explicitly spelt out in the IBC,” the IGIDR paper said.
 
Besides, removal of core management group from the companies referred to the NCLT and putting an insolvency professional at the helm of affairs has proved to have its unintended consequences.
 
Falling production
 
With auditors running steel companies, and banks refusing to lend more funds, production at the NCLT-referred companies are falling, compared to a rise in production just before these companies were referred by the RBI to the NCLT.
 
For example, Essar Steel’s steel production was down 15 per cent on a month-on-month basis in August and September since the insolvency resolution professional took charge.
 
After these companies were referred to the NCLT by the lenders, their suppliers and customers have also withdrawn support, thus impacting their flows and lowering the valuation of their assets, said a company source.
 
This is bad news for the lenders who are expecting that they would recover part of their loans worth Rs 200,000 crore by selling assets of these companies to the highest bidder. The insolvency and resolution professionals (IRPs) are expected to drive faster resolution of the restructuring process of the 12 companies that were sent to the NCLT by the lenders following prodding from the RBI.
 
Along with the committee of lenders, IRPs were given the responsibility of getting stressed companies back on track within 180 days, which could be extended by another 90 days. Of the 12 companies that were referred to the NCLT, only four, including Essar, Bhushan Steel, Monnet, and Amtek Auto, have operating assets.
 
In its June 13 press statement, the RBI had said its internal committee had identified 500 accounts as on March 16, 2016, that had more than Rs 5,000 crore of debt, and of this, 60 per cent had been declared as NPA by the banks. With the recent Gujarat HC observations, all the 500 accounts were to be accorded same priority by the NCLT instead of RBI’s earlier instruction to give priority to 12 companies. After the initial list, the RBI is preparing another set of companies that would go to the NCLT.
 
Company promoters say the RBI should reactivate its earlier programme under which corporate debt was divided into sustainable and unsustainable debt, and there was a freeze on the repayment of interest on the unsustainable debt part.