Insolvency Code: will it reduce NPAs?

Prime Minister Narendra Modi has called the Non-Performing Assets (NPA) issue a larger scam than 2G, Commonwealth Games, and coal scams, terming it the "biggest scam of the UPA government".

Introduced in the Lok Sabha soon after the issue arose was the Insolvency and Bankruptcy Code (2016), in order to deal with the NPA issue as well as improve India's position in the World Bank's Ease of Doing Business ranking.

According to economic theory, ease of exiting non-performing businesses is as important a metric in the proper functioning of an economy as ease of entering.

Furthermore, the issue has not gone away; gross NPAs of the state-owned banks has risen from Rs 1,76,000 crore
in June 2013 to Rs 8,29,338 crore in June 2017 while NPAs of private sector banks rose from Rs 22,020 crore to Rs 1,00,481 crore in the same period.

This is largely down to new recognition criteria set by the Reserve Bank of India (RBI) in an Asset Quality Review initiated in 2015, although the figures are alarming and shed new light on the scale of the problem. As a percentage of gross loans, the non-performing loans are at a shocking 9.2%, one of the highest among large economies.

The Insolvency and Bankruptcy Code (2016) is supposed to tackle this problem as it lays down a time-bound process in which it is supposed to address the distressed corporates and individuals.

A repayment plan is to be put in place within 180 days  for the corporates, with a 90-day possible extension, failing which the company goes under liquidation.

In a year since the framing of the law, 515 petitions were made to the National Company Law Tribunal (NCLT) of which a majority were filed by operational creditors and a third were admitted and are in various stages of insolvency.

Anecdotal evidence suggests that the process is working for two reasons. One, hitherto, operational creditors had little recourse to the law as it was fragmented and unstructured and the process was messy and not time bound.

Under the Insolvency and Bankruptcy Code (2016), operational creditors for the first time have a law with teeth in it, as under the law, once proceedings are begun, the management of the distressed company is handed over to an insolvency professional and managements are wary of losing control of their companies.

Second, the Punjab National Bank managing director said in an interview to a financial newspaper that the new insolvency law "will give a good message that if you do not meet your financial commitments, you will not be able to retain your assets," giving defaulters yet another reason to settle their dues.

The RBI has taken unprecedented steps under the new law to clean up the banking system and reinfuse capital. It has sent a first list of 12 companies to the NCLT for immediate insolvency as well as a second list of 28 companies after that.

It has also asked banks to resolve bad loans at 40 of the biggest defaulters within a year. The initial list of 12 companies include companies like Essar Steel India Ltd, Bhushan Steel Ltd, Jyoti Structures Ltd, Jaypee Infratech Ltd and ABG Shipyard Ltd.

Of the companies in the lists, the Punjab National Bank, for example, has exposure to 29 amounting to a total exposure of Rs 65 billion (Rs 4.22 lakh crore). The RBI move will help PNB as well as other banks exposed to this debt and avoid huge haircuts.

The government will infuse Rs 2.11 trillion (Rs 2.11 lakh crore) into the banks hoping to kick-start an investment cycle. The infusion will happen in the form of recapitalisation bonds - to the tune of Rs 1.35 lakh crore - as well as budgetary allocation from the government.

Teething troubles

Teething troubles are inevitable in any large-scale transformation in judicial and legislative matters and in order to meet these troubles, the Lok Sabha has passed the Insolvency and Bankruptcy Code (Amendment) Bill 2017.

The primary change is that promoters of non-performing assets are now ineligible to submit resolution plans for that asset or in simple language, they can't buy back their companies at a lower discounted rate.

This is a 'moral hazard' to the banking system as it incentivises promoters to still default as they can simply buy their company back at a lower price. The amendment plugs this loophole. It, however, does allow promoters to pay their overdue debts and then become eligible to buy back their companies.

In sum, these measures would seem in theory be able to improve India's Ease of Doing Business ranking as well as reduce the NPA problem.

The evidence thus far, however, is scant as the law has barely a year under it and delays are inevitable with a gigantic problem such as the one on our hands. The prime minister had assured a solution in 2017, but with 2018 starting, this seems to be another hollow promise.