NPAs have been in the news regularly for a while, and there has been a fair bit of doomsaying around them of late. Ever since the Nirav Modi-Punjab National Bank fraud became public knowledge, the central government seems keen to be perceived as being on a war footing against NPAs. There is a constant stream of news on Non Performing Assets of banks. Massive numbers - thousands of crores of rupees- are reported to the point where NPAs probably deserve their own segment in business news. They’ll be more interesting than weather forecasts for sure.
Let’s deconstruct this NPA business and try to understand what is going on.
An NPA, or a Non-Performing Asset, is a way of classifying loans or advances that are in default or are in arrears, on scheduled payments of principal or interest. Meaning, the principal or interest payment remained overdue, generally a period of 90 days. Bank consider loans that they have given as assets. An asset is classed as non-performing when it does not generate income for the lender anymore.
The total amount of such bad loans across the banking sector, what’s known as Gross NPA, was estimated to be around 8.4 lakh crores in December. This number is expected to hit a peak of 11 lakh crores when updated figures are released later. The Hindu reported in February this year than in March 2017, public sector banks accounted for 6.8 lakh crore of the 7.9 lakh crore bad loans; private sector banks held 91,900 crore and foreign banks the rest. In December, it claimed, “…stressed assets held by Indian banks amount to around Rs.10 lakh crore or $150 billion, roughly twice the GDP of Sri Lanka.” Estimates suggested that PSBs accounted for over 88% of the total gross NPAs in December. These NPAs account for 12% of all banking loans in the country.
Gross NPAs in Indian banking have swelled 135% between December 2014, when they were at Rs2.61 lakh crore and December 2016, when they stood at Rs6.97 lakh crore. By March 2017, the average bad loans of PSBs were about 75% of their net worth. Around this time last year, the situation was already dire. For every Rs100 that they lent out, Indian banks were likely to get back less than 90 rupees.
Some analysts claim that trouble began with the crisis of 2008. Remember the collapse of Lehmann Brothers and all those documentaries you watched which tried to explain the crash? That’s when things started to go bad. Terrible year, 2008.
Anyway, the Indian economy was chugging away at a healthy pace. Between 2006 and then, it had grown at around 9-9.5%. So many companies borrowed aggressively for their expansion plans. When the slowdown happened in 2008, it wreaked havoc on these companies’ repayment abilities. Banks have become cautious since then. Loan growth now hovers around 3%. It is believed that the top 10 business group borrowers have to repay around Rs5 lakh crore to banks.
To give a famous, or notorious, example, consider Kingfisher Airlines. As the Indian government closed in on him for not repaying his loans, Mr Mallya quickly relocated to England. That was in 2016. Last month, the NSE decided to delist the airline. Government authorities are cracking down on shell companies—listed as well as unlisted—for being, allegedly, used as conduits for illicit fund flows. After the delisting, Mallya will not be able to tap Indian stock markets for funds for any future business ventures for 10 years – that’s 2028 when he will be 72 years old. Additionally, he will be liable for any repayments ordered.
To sum up, that infamous case, six years after the company went belly up, accumulating a debt of 9000 crores, his company has been delisted and he is barred from trading on the stock markets for 10 years. Those 9000 crores are now non performing assets for many major Indian banks like SBI, IDBI etc. The State Bank of India had lent Vijay Mallya’s airline over 1400 crores. The loans given out to Kingfisher Airlines were classed as an NPA by the SBI back in 2012.
What of the Reserve Bank, one might ask? Surely it must be doing something to address the issue. Well, it has been trying but no real results have manifested as of this writing. In February 2014, it introduced the joint lenders forum, or JLF. This allowed banks which had disbursed loans to specific companies to consider a collective mechanism to resolve the problem. Predictably, the banks didn’t agree on much and the expected recoveries remained elusive.
So the RBI introduced a strategic debt restructuring scheme in June 2015. Some analysts are of the opinion that it was merely old wine in a new bottle, a new version of the failed corporate debt restructuring scheme from 2001. It allowed banks to buy a stake in defaulting companies by converting debt into equity. The plan saw no takers because banks were dependent on promoters for the plan’s resolution. And there were no buyers for such equity. In 2016, the RBI pushed for the sustainable structuring of stressed assets. This allowed banks to restructure large loans where the projects were up and running. As it was applicable only to active projects, it met with limited success, if at all.
Bankers reportedly told the media that the RBI’s measures were falling short because the slump at the ground level was not reflected in India’s GDP data. “Bad loans are a culmination of the economy’s slowing down, stalled projects, and licences of players from some industries being called off,” according to NS Venkatesh, executive director at Lakshmi Vilas Bank, a private lender.
Finally, one year ago, the RBI prepared a list of the dirty dozen – 12 companies that were the largest borrowers, accounting for 25% of all the bad loans in the country. The central bank demanded that this dirty dozen be immediately taken to bankruptcy courts.
Which brings us to the big-ticket move by the government to tackle the NPA problem – IBC. The Insolvency and Bankruptcy Code, what the Economic Times called the biggest economic reform in India after the GST, is a rare instance of an efficient implementation of a new law.
Authorities claimed the law would extract the highest possible value from an asset within a specific time. Its selling point was the 180-day timeline, extendable to 270 days, within which the resolution plan is to be approved.
The Insolvency and Bankruptcy Code 2016 was implemented through an act of Parliament. It received Presidential assent in May last year and was put into use as quickly as August 2017. The IBC has become a centerpiece in the govt’s war on NPAs. So how does it help?
Firstly, IBC highlights insolvency processes for individuals, companies and partnership firms. Both debtors and creditors can start 'recovery' proceedings against each other.
Second, as mentioned earlier, businesses must complete the insolvency exercise within 180 days under the new code. The deadline can be extended if creditors do not object to the extension.
Third, smaller companies - this includes startups with an annual turnover of Rs 1 crore - the insolvency exercise must be completed in 90 days, with a provision for extension of the deadline by 45 days.
Fourth, IBC permits the hiring of the services of licensed professionals who have total control over the assets of the debtor while the proceedings are on at a tribunal.
Five, Two tribunals have been authorised to resolve insolvency issues and pronounce judgement. For businesses, it is he NCLT or National Company Law Tribunal. In the case of individuals, the authgoprised tribunal is the Debt Recovery Tribunal.
Before the IBC, reorganizing and/or winding up a business was subject to discrete laws. There was no assurance that debt could be recovered under the then prevalent laws like the Contract Act, Recovery of Debts Due to Banks and Financial Institutions Act 1993, Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act 2002
The organizations’ recast under the SICA (Sick Industrial Companies Act) or winding-up under the Companies Act 1956 was not usually successful. Further, laws dealing with individual insolvency were outdated, dating back nearly 100 years.
The process of recovery in India was usually rather protracted, sometimes taking even 15 years. On average, India takes four years to declare a promoter or a company insolvent, which is more than twice the time taken in China or the United States, according to World Bank data. Consequently, Indian banks recover a mere 25 cents to a dollar in India, compared to 36 cents in China and 80 cents in the US.
Under the IBC, insolvency proceedings can be initiated even with a default of above Rs 1 lakh, based on payment default. The new structure under the IBC allows a time-bound resolution of insolvency and gives genuine business failures a second chance. Under the new consolidated bankruptcy law, control shifts from shareholders/promoters to a committee of creditors. The process under the new code rests on four pillars. Insolvency professionals, Information utilities, adjudication and regulation. Insolvency professionals now have a significant role to play in the bankruptcy process.
They will be regulated by insolvency professional Agencies. Information utilities will electronically store data about lenders. The National e-Governance Services Ltd or NeSL is the first registered IU or Information Utility. Adjudication will be the responsibility of the NCLT or the National Company Law Tribunal in cases of business insolvency. Debts Recovery Tribunals will oversee bankruptcy cases of individuals and unlimited liability partnerships. The requisite appellate authorities have also been put in place - NCLAT and DRAT. A regulator, the Insolvency Bankruptcy Board of India, IBBI, will be the central agency at the top of this chain.
The dirty dozen identified by the RBI, who account for approx. 2.7 lakh crores of NPAs, will be sent to the IBC for resolution. And while reservation remain about the speed of change and the long term success of this law, it has received applause, even if restrained, for some early success.
First Big Bankruptcy Success Hands $5.2 Billion to India Lenders, went a Bloomberg headline. Tata Steel bought insolvent Bhushan Steel and will pay $5.2 billion, or approx. 35000 crores, to Bhushan Steel’s creditors. This is about 63 percent of the 56,000 crore rupees claimed by a consortium including SBI, PNB, the two biggest government-run lenders in India, and the insolvent company’s largest creditors.
Banks provisioned for a discount on the outstanding debt of more than 50 percent, according to Ravikant Bhat, an analyst at Emkay Global Financial Services Ltd. “The successful resolution of Bhushan is a positive structural development for the banking sector,” he said to Bloomberg. Interim Finance Minister Piyush Goyal, standing in for Arun Jaitley, who’s on sick leave, tweeted, “The non-performing asset resolution process is being done through a fair and transparent Insolvency and Bankruptcy Code helping boost both the banking sector and the economy.”
While analysts and experts agree that the IBC is a game changer, they point out that it is prone to the usual delays that haunt Indian industry. For instance, the day after the NCLT approved Tata Steel’s resolution plan for Bhushan Steel, an aggrieved promoter of the debt-laden firm reportedly moved the appellate tribunal challenging the NCLT order. Meaning an uncertainty is still hanging over Bhushan Steel. Another instance is in the Electrosteel insolvency proceedings.
The Kolkata bench of the National Company Law Appellate Tribunal or NCLT had approved a resolution plan from Vedanta for Electrosteel Steels Ltd, endorsing the view of the committee of creditors. The creditors had approved the bid of Vedanta on March 29, 2018. Then, the NCLAT, which hears appeals, admitted a petition by Renaissance Steel challenging the eligibility of Vedanta in the Electrosteel Steels insolvency process. This case is now being heard in the NCLAT heard and the resolution remains, in effect, incomplete. So the IBC, while a big step forward, still has a few loopholes that need to be plugged.
There is another development with the IBC coming into effect. It is luring offshore investors who have expressed interest in buying the bad loans. CDPQ, a Canadian pension fund manager, has made $600 million available to the Edelweiss Group for investing in such assets. A Hong Kong firm, SSG Capital Management Ltd, sees opportunities in such assets, and foreign funds including Oaktree Capital Group and Varde Partners seem keen on participating in this nascent market.
One analyst noted that foreign funds see significant value in problem assets and are willing to bring in management and expertise to run the distressed companies. SSG Capital Management, which oversees more than $4 billion, has deployed a significant amount of capital in India, according to its Chief Investment Officer Edwin Wong.
The sale of distressed assets from banks to third-party investors went up in the last fiscal, according to SC Lowy Financial of Hong Kong. “We have seen an increase in fund managers pivoting their efforts from other jurisdictions towards India,” an expert from the firm said.
Most of the big lenders, including ICICI Bank and SBI, are keen on selling parts of their bad loan portfolios to asset reconstruction companies in the coming weeks instead of waiting for the resolutions, as per the Economic Times. Seven banks, including IDBI Bank, are in the process of selling outstanding loans worth approx. Rs 28,000 crore. The largest share of such bad loans belongs to IDBI, which has identified 30 accounts worth Rs21,399 crores in unpaid dues. IDBI has total bad loans that make up 28% of its loan book — the highest in the banking sector. The trigger for this sale is the loophole allowing for unending litigation under the IBC as well as a desire to restrict their share of bad loans to under 6% - the mark at which Reserve Bank of India will initiate corrective action. Estimates indicate this ratio had swelled to 13.5% in the fourth quarter.
As of 23rd May 2018, 26 private and public sector banks reported gross non-performing assets in excess of Rs7.3 lakh crore, with PSB’s adding an additional Rs1 lakh crore to their share in the January to March quarter this year.
We discussed recently the centre’s recapitalization plan for PSBs. However, losses reported by these banks have nearly wiped out all of the $13billion capital infusion by the government. Worse, rating agency Fitch announced the situation is unlikely to improve in the current fiscal year. 19 of 21 state-run banks reported losses for the fiscal, including SBI. Even resilient private sector banks were not immune, with Axis Bank reporting its first quarterly loss. The $11billion in capital committed by the government for FY19 will help banks avoid breaching regulatory triggers, but more government capital is required to stabilise balance sheets, meet regulatory requirements and support growth, observed Fitch.
Ultimately, the impression one gets is that the govt seems to be working on a clean-up while holding the banks accountable. A senior official told the media that the government is aiming to make bankers take responsibility for their lending decisions. “There has to be some accountability. Bankers have to know details of all their big accounts and act when there are instances of deliberate fraud,”
according to Mint. “Bankers now know that they cannot any longer hide NPA accounts by providing fresh loans to defaulters,”