Wednesday, July 14, 2021

Question mark over IBC process

I return to my blog after a long lay-off caused by various discloations. Somme recent resolutions under the IBC process have triggered a huge controversy, thanks to poor recoveries on bank loans. 

 It does appear that trying to mimic America's Ch 11 bankruptcy process in India has its shortcomings. Many decisions of the NCLT are challenged in courts. The process of resolution stretches out, causing an erosion in the value of assets. Also, we need deep pools of debt capital that can finance biddders so that the auction process is competitive enough Finally, bench strength at the NCLT needs to be increased to expedite hearings. 

Lacking these elements, banks cannnot hope to recover much. Banks must first try to resolve defaults through negotiation and restructuring. Only then should they approach the NCLT. Given the fear of investigative agencies, the IBC has become the default option.


 Bankruptcy process needs a re-look 

A mechanism is needed to ensure bank-led resolution— not the NCLT— is the first resort for lenders Bankers are finding out that the National Company Law Tribunal (NCLT) is an expensive saloon to visit. 

The hair-cut on the sale of Videocon to the Vedanta group is 95.85 per cent, that is, banks will recover only 4.15 per cent of their total admitted claims of Rs64,838 crore. Videocon companies will be sold for a price of Rs 2,962 crore. The fair value was assessed at Rs 4,069 crore. Talk of a terrific bargain. 

The Videocon, offer, the NCLT bench noted, is close to the estimated liquidation value of Rs 2,568 crore. The liquidation value is to be kept confidential and disclosed to the banks’ committee of creditors only at the time of finalisation of bids. The bench seems to be hinting at a possible leak of the liquidation value. 

The danger in such a leak should be obvious. If a bidder believes there will not be any serious bidder in the fray, he can take his chances by quoting a price close to the liquidation value. Further, if a bidder acquires a company at the liquidation value, he may not have any great incentive to run it. He may choose to liquidate if he judges that he can realise, say, 15 per cent more than the estimated liquidation value. The point about selling a company to a bidder is to keep the concern going, to preserve jobs and incomes. Where it is sold at close to the liquidation value, this objective may be defeated. There is nothing in the statutes that prevents a bidder from liquidating a company after having submitted a resolution plan.

In another case, Siva Industries, the banks sought approval from the NCLT for a settlement with the promoter at a hair-cut of 93 per cent on outstanding debt of Rs 4,863 crore. The NCLT bench has sought an explanation and reserved its order. This is the sort of hair-cut that banks would find it difficult to take on their own. They must reckon that doing so under the auspices of NCLT gives them cover—“We followed due process.” 

One of the primary motivations for creating the IBC route was to improve recovery for banks. They weren’t recovering enough through restructuring, one-time settlements and sale to Asset Reconstruction Companies (ARCs). With ARCs, very little reconstruction was happening. They were just a means for banks to hand over the liquidation process to a third party. Recoveries were poor as a result. The hope with the newly constituted National Asset Reconstruction Company Limited is that we will see serious asset reconstruction. 

Is recovery any better at NCLT? According to Macquarie Securities, recovery under NCLT has averaged 24 per cent if we leave out the top nine accounts referred to the NCLT by the Reserve Bank of India. We should not be surprised. Only 8 per cent of cases have been resolved. Thirty per cent of cases have undergone liquidation. Banks need to see if recoveries in bank-led resolution in the recent years are better. 

Bank-led resolution, not the NCLT, should be the first resort for banks. They should be able to keep enterprises going through restructuring wherever possible. This doesn’t happen as much as it should because, in the public sector, bankers fear the law enforcement agencies may come after them—even years down the road. They need a mechanism that gives them protection for hair-cuts they take. It is the absence of such a mechanism that has made the NCLT the first resort ever since it came into being. 

Auction of assets will not automatically lead to the discovery and realisation of the best price. The auction has to be efficient. And the conditions for an efficient auction, such as multiplicity of bidders, correct reserve price, etc are so onerous that these are rarely met even in advanced economies. Besides, resolution under NCLT has been plagued by delays caused by litigation and the sheer volume of cases. Macquarie estimates that cases take more than 400 days, whether for liquidation or resolution, against the stipulated time limit of 270 days. Bidders will know that acquiring an asset would stretch out in time and assets will shed value in consequence. They will tailor their bids accordingly. 

It’s not clear how well assets for sale are advertised in NCLT cases. In some cases at least, investment bankers should be entrusted with a mandate to find suitors on a global basis. Private equity funds must be sought out. Banks are, perhaps, better equipped to do this. 

There is also a case for revisiting the exclusion of promoters from bidding where promoters are not wilful defaulters. An NCLT bench had recently suggested that the promoters be given a chance to bid in the DHFL case. Banks were outraged at the suggestion and have taken the case to NCLAT. Bankers are right in thinking that allowing promoters to bid for assets after they have defaulted creates moral hazard. But there are many cases where default occurs for reasons beyond the control of the promoter. By all means, penalise wilful defaulters. But don’t treat every default as a moral issue and rob banks of decent recovery on their loans. 

Here’s a thought. Let promoters, who are not wilful defaulters, be allowed to bid at NCLT. Where bankers feel that a promoter’s track record does not inspire confidence, they should have the right to reject promoters who have won the bid and opt for the next bid after placing their reasons on record. Some will say that giving discretion to bankers will result in abuse. But the absence of such discretion results in a bigger abuse, namely, poor recovery on loans. The bankruptcy process needs a re-look if Videocon and Siva Industries are not to become the norm. 

Air of optimism on banking 

 The dog did not bark. Non-performing assets (NPAs) did not rise as much as feared. That’s the interesting thing about Indian banking in the time of the pandemic. There’s no mistaking the optimism in the RBI’s latest Financial Stability Report (FSR). The FSR of January 2021 had said that NPAs in the baseline case— which is the best case— would be 13.5 per cent of advances by September 2021. Now it estimates the baseline NPA at 9.80 per cent in March 2022, just a tad higher than the figure of 9.5 per cent in March 2021. “RBI sees NPAs at 14.8 per cent,” some headlines had screamed last January. That was the estimate for the worst case scenario in September 2021. Now, the RBI says that, in the worst case, NPAs would be 11.22 per cent in March 2022. What do the RBI’s revised numbers mean? First, that the second wave of the pandemic has left the Indian banking sector largely unscathed. This would be a truly astonishing outcome if the RBI’s estimates for the coming year are proved right. It would show how much stronger the banking system is today after the crisis years of the past decade. It would also be proof that the macroeconomic impact of the second wave is nowhere as bad as the doomsayers had predicted. Your columnist stands vindicated.