35 highlights
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When one looks back at the history of bad loans in the Indian banking system and the various attempts by bankers to recover their dues, the term “delay” will feature prominently at every step of the process.
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One example is Amtek Auto.
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By February 2020, bankers accepted a revised resolution plan that was submitted by US-based hedge fund Deccan Value Holdings. By June 2020, Deccan’s offer to take over the company was accepted by the NCLT and banks were ready to finalize the deal.
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But Deccan decided to pull out—the COVID-19 pandemic, it said, forced it to re-evaluate the offer and examine the impact on Amtek’s finances. The hedge fund argued that COVID-19 was a “force majeure event”, therefore it had the right to terminate its resolution plan.
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And Amtek Auto is back to square zero.
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The company, which owed banks over Rs 9,000 crore in loans, was on the “dirty dozen” list of big corporate defaulters referred to the bankruptcy process by the Reserve Bank of India back in 2017.
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In the Amtek case, it was initially expected that the Liberty House Group would take over the company after its plan had been accepted by bankers and the National Company Law Tribunal in July 2018. But Liberty never paid up, and so the lenders moved the NCLT to order a fresh resolution process.
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In the five years since the bankruptcy code came into effect, to much fanfare, bankers have spent countless hours deliberating on resolution plans for defunct companies. They have paid lawyers and resolution professionals hefty fees to manage these cases and have tried to thwart attempts by former promoters to buy back their defaulting or bankrupt companies at a discount.
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Last month, National Asset Reconstruction Co. Ltd, or NARCL, was incorporated. So far, eight state-owned banks have pumped equity capital into the new bad bank.
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But a little over a month from its incorporation, very little has happened at the bad bank, and it looks like the government and the regulator are dragging their feet. On top of that, big questions remain on how NARCL will actually work—from the price at which it will buy bad loans from banks to how the government will curtail losses if recoveries are low.
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Effectively, the bad bank would buy up bad loans that were sitting on the balance sheets of banks. This would shift the risk and legal pain of dealing with large corporate defaulters away from the banks to an independent agency. This also removes the need for multiple lenders, with differing incentives, to argue and agree upon a resolution plan, a process that has often slowed down cases under the Insolvency and Bankruptcy Code.
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Because each bank will have a different exposure to a specific corporate debtor and each of them sets aside different provisions against the NPA account, each has a different valuation of how much they should recover from the defaulter.
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And so, deliberations between bankers under the IBC process takes time as they have to coordinate and agree on the same recovery process, be it the liquidation of a defaulter company or the sale of the company to a new owner.
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There is a big brother problem in the committee of creditors, where minority banks accept whatever deal is approved by the big ones
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According to the bankruptcy code, a resolution plan can be approved with a minimum of 66% of votes at the committee of creditors. In many instances, however, banks with smaller exposures have challenged deals, since the haircuts that the larger creditors accepted left the smaller ones with barely any recoveries.
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So NARCL is one way to stop the bickering and legal appeals among bankers. Instead of multiple bankers deliberating on whether a prospective deal is appropriate, under the bad bank model only one entity is responsible for taking the decision.
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The government has opted for a two-tier structure wherein NARCL will act as a warehouse for the bad debt and a subsidiary entity called India Debt Resolution Co. Ltd, or IDRCL, will manage the debt resolution and recovery process. IDRCL is yet to be incorporated.
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There is no specific bar on promoters buying out their companies under the SARFAESI rules, while Section 29A of the IBC specifically bars promoters from bidding for their own companies. There may be a few cases of promoters buying their own companies from the ARCs after they buy the debt from the banks
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The SARFAESI Act of 2002 is an older law covering debt recovery; with IBC coming into force in 2016, lenders could choose to take a defaulter to bankruptcy court instead of using SARFAESI provisions. However, asset reconstruction companies—ARCs for short—like NARCL by default operate under the SARFAESI rules, unless the bankruptcy code is specifically invoked.
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A second executive working on the NARCL matter says that they are waiting for regulatory approval for private-sector banks such as HDFC Bank, Axis Bank, ICICI Bank and IDBI Bank to make their investments into NARCL, while internally the banks are ready.
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The character of NARCL will be more of a public entity, while IDRCL will have a more private characteristic
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For the bad bank to succeed in recovering value for the banks, it all depends on the companies it acquires, the economic value remaining in these companies and the process through which it buys the NPAs from banks.
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There are two issues delaying NARCL from beginning operations. The first is the price at which it buys bad loans from banks—it needs to be fair to the lenders, but also realistic enough for it to make a profit in the long run.
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“The more you delay, the more is the economic loss of the assets and, therefore, the valuations of the company drops.”
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IBC cases have taken 459 days to resolve on an average, as opposed to the 180-day requirement under the code (extendable by a maximum of 90 days), according to the latest quarterly data from the Insolvency and Bankruptcy Board of India.
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Due to these elongated timelines caused by legal complexities and litigation, the value of assets of the insolvent company erodes considerably, which means there are no takers for these assets.
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For large assets, finding buyers will be a problem and this will be reflected in the prices. If NARCL wants to sell the asset and find enough buyers, the price will need to be low. So ultimately the loser will be the banks
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Under normal circumstances, RBI regulations require banks to conduct an auction and seek bids from asset reconstruction companies. In this process, the highest bidder wins. The rules also state that ARCs can purchase NPAs from sponsor banks only on an arm’s length basis and at market determined prices.
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If another buyer comes forward for the banks’ assets there will be an auction process which the NARCL will have to compete with. If not, the NARCL will propose a price which the banks would need to accept or not
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Furthermore, since the NARCL model requires banks to fund the purchase of their own assets, through the bank, it involves a circuitous flow of funds. This is another aspect that RBI would need to evaluate when issuing the licence.
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NARCL may be the sole bidder for these assets, says the banking analyst quoted above. “This raises the question of what price they will buy the NPAs at and the haircuts banks will need to take.”
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According to several media reports, bankers have asked the government to provide a Rs 31,000 crore guarantee on the security receipts issued by NARCL.
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To be clear, this is not a 100% guarantee. Rather it seeks to ensure that the banks do not incur a loss on their security receipts over a five-year period in case NARCL and IDRCL are unable to maximize the recovery from a defaulting company.
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This is effectively a moral hazard and the guarantee could act as a disincentive for NARCL and IDRCL to recover as much as it can from every asset, says the insolvency professional quoted earlier.
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But there is a “lack of enthusiasm” from the government, regulators and bankers, says the insolvency professional. Ultimately, this might be the only problem holding NARCL back from taking charge of these accounts and getting on with resolving Indian banking’s mountain of bad debt.