Why Modi government deserves huge applause for the Insolvency and Bankruptcy code

While it was a known fact that Bank NPAs had been growing consistently under UPA 2, the true extent of the issue was uncovered only under the current NDA government.

“Deep Surgery” of India’s Banking system started in second half of 2015, with RBI conducting Asset Quality Review (AQR), a one-time special review of most of the large borrower accounts across the Banking system. AQR revealed a much higher asset quality deterioration than was earlier known. Many banks were found to be hiding bad assets under the practice of forbearance(a temporary repayment relief). AQR overrode such practices and helped determine the accurate level of bad loans that were earlier unreported by Banks. Not surprisingly, the true NPA level shot up and are now projected to be INR 9.5 lakh crore in March 2018, from INR 2.78 lakh crore in March 2015.

To emphasize the enormity of this crisis, INR 10 lakh crores (US $150 billion) is larger than the GDP of 130 countries. Due to legacy issues from previous governments, this amount is stuck with corporate borrowers, not returning to the banks, thus choking the credit growth, blocking the capital availability for other growing businesses and impeding India’s economic growth.

From IMF’s 2016 data, India’s bad loans (8.6%), were much higher than other prominent economies like China, Japan, USA or UK where this is below 2%

India’s Bad Loans compared to other economies (source: here)

In order to address the issue of mounting NPAs, Insolvency and Bankruptcy Code (IBC)was passed in May 2016, which created a one-stop solution for resolving the insolvencies. The greatest strength of IBC is that it set a strict time limit for cases and the process could not go beyond 270 days (9 months).  Shortly thereafter in June 2016, National Company Law Tribunal (NCLT)was constituted as a quasi-judicial body with the responsibility of overseeing the insolvency process under IBC.

In June 2017, RBI identified 12 accounts (“The Dirty Dozen”), each having more than INR 5,000 crore (US $745 million) of outstanding defaults. These 12 accounts comprise 25%of total NPAs of banks.

Top 12 accounts with largest default amounts

IBC started showing results in May 2018, when NCLT approved Tata Steel’s resolution plan for Bhushan Steel. Yesterday, Tata Steel formally took control of Bhushan Steel settling about Rs 35,200 crore, or nearly two-thirds, of the loans owed to lenders. Banks, which though have taken a more than 37% haircut on their outstanding loans of Rs 56,079 crore, can now classify the assets as standard, reducing their bad loan burden. They are expected to reverse the provisions they had made against the account, significantly boosting their first-quarter results

Further, the RBI has also created a second list of 28 accounts for resolution under IBC. These accounts together amount to 40% of bad loans and are expected to be resolved by 2019. To address willful defaults in future, the government has also rolled out “Fugitive Economic Offenders Ordinance” in April 2018. This bill allows Government of India to henceforth confiscate all assets within and outside the country, of loan defaulters and fraudsters who have left the country to avoid facing criminal prosecution.

In a nutshell, between 2018 and 2019, 65% of total bad loans amount will be addressed by NCLT from the two lists of 40 account submitted by RBI. Many other smaller accounts are being addressed separately. NCLT benches (currently 11) may also be increased to support a speedier resolution. The NDA government deserves credit for –

  • Rolling out the much-needed Insolvency and Bankruptcy Code (IBC) as a framework which provides 6 months (extensible by 3 months), time-bound insolvency resolution process
  • Arresting the leakages and bringing a part of the capital back into the system, which was completely lost in defaults
  • Further strengthening the banking system with INR 2.11 lakh crore (US $30 billion) recapitalization plan for state-run banks
  • Preventing loss to country’s wealth in future by “Fugitive Economic Offenders Ordinance” which enables Government of India to confiscate assets of economic offenders who leave the country

It’s still early days and one needs to wait for more results, but it’s a promising indicator if Stanley Pignal (Banking Editor at The Economist), who is quite vocal and generally critical of Indian Government’s economic policies also gives a thumbs-up to IBC and says this

“It used to be Indian tycoons could borrow as much as they wanted & default with no fear of losing “their” companies. No more. The impact is potentially far reaching”

“A tough bankruptcy code, chastened banks and probity in Delhi have dealt a blow to cronyism”

Shashank Goyal: IIM-A alumnus, Software Sales Professional, Writes about business, economy and politics; Passionate about numbers, facts and analysis Tweets @shashankgoyal01