Many things have been tempted by the government and the Reserve Bank to deal with the bad debt problem that has plagued India’s banking system for a long timefrom recovery courts to the mechanism for the sustainable structuring of stressed assetsbut with little success. The Insolvency and Bankruptcy Code implemented five years ago was widely seen as a solution that would work. He had some early success. But after that, recoveries fell sharply and business began to drag on, plunging some banks into existential crisis.

Now the government has a solution for thisa bad bank, which will take over some of the banks’ nonperforming assets, reducing the strain on their balance sheets while trying to get better resolution for the assets.

Bad banks, or Asset Reconstruction Companies (ARCs), are not new to India, but their impact has been limited because they were all in the private sector. The process of selling and transferring bad debts to private CRAs has been very slow due to valuation issues and the huge initial capital required to purchase large non-performing assets. The government’s bad bank, or National Asset Reconstruction Company Ltd, should address these issues. “NARCL is expected to buy back Rs2 lakh crore of bad assets over time, which would be 45% of what all ARCs have collectively acquired through March 2021. This is important, not just in the context of industry NPAs banking but also for the ARC ”, declared Krishnan Sitaraman, senior director and deputy director of the rating at the rating agency CRISIL.

In the first batch, bad debts worth Rs 90,000 crore should be transferred to NARCL.

NARCL and the India Debt Resolution Company (IDRCL) will play a vital role in the management and resolution of bad debts for large corporations. NARCL, in which public banks will hold 51 percent of the shares and private sector lenders the remainder, will pool and consolidate distressed loans. It will pay up to 15 percent of the NAV upfront in cash and security receipts will be issued for the remainder. The government will provide a guarantee of Rs30,600 crore for these security receipts.

“The sovereign guarantee will support the RBI’s regulatory provisioning requirement and allow banks to release that capital without the burden of additional provisioning, effectively allowing greater involvement of banks to resolve their NPAs through the wrong bank,” he said. said Anish Mashruwala, partner, J. Sagar Associates.

The IDRCL, of which public sector banks and financial institutions will own 49 percent, will manage assets and hire market professionals and turnaround experts.

Some of the NPAs are several years old and the recoveries in such cases have been dismal. “The average recovery rate for insolvency proceedings with the exception of some large assets started out in double digits. Most of the Rs 90,000 crore in the first phase will come from Lists One and Two that the RBI asked banks to go through the insolvency process a few years ago. The chances of physical recovery of these assets appear low, ”said Nilanjan Karfa and Amit Nanavati, analysts at Nomura Securities.

Thus, the efficiency with which stressed assets are resolved under a new mechanism will be a key element to watch. “It can be argued that the bad bank is likely to become a warehouse for troubled loans without an expected recovery, as it will be difficult to find buyers for legacy assets,” said Kunal Shah, analyst at ICICI Securities. “If the initial cash flow is more or less equal to the amount invested by the banks, then would it be just a matter of moving the problem from one place to another without fundamentally solving it?

This could, however, to some extent solve the problem of banks being cheated in resolutions. According to the Insolvency and Bankruptcy Board of India (IBBI), as of June 30, 2021, there were 396 insolvency cases with approved resolution plans. Of the total claims over Rs6.82 lakh crore, financial creditors could recover just under Rs2.46 lakh crore, or only 36%.

In the approved resolution of Videocon’s bankruptcy, Twin Star Technologies’ bid from billionaire mining baron Anil Agarwal was Rs 2,962 crore. Claims allowed were Rs 64,838 crore, which meant lenders would have to adopt a haircut over 95%. Bank of Maharashtra, which held a small portion of the loan, appealed the order to the National Company Law Appeal Tribunal and obtained a stay.

More recently, on August 12, the Chennai judiciary of the NCLT ordered the liquidation of Siva Industries and Holdings. The company’s former promoters had proposed a one-time settlement of Rs328.21 crore, which was rejected by the court. The claims allowed in this case from financial creditors were Rs4,863.87 crore. Claims from operational creditors and other creditors were Rs461.02 crore and Rs40.55 crore respectively.

In the resolution of bankrupt carrier Jet Airways, which was sold to a consortium of Kalrock Capital and Dubai-based businessman Murari Lal Jalan, financial creditors would only recover 5% of their total debts of around 7,807 crore rupees.

Legal experts criticize lenders for accepting such small payments in some of these resolutions. “India’s bankruptcy resolution system is hampered by low collection rates and long delays. The banks got a bad deal in the Videocon and Jet Airways cases and this was due to creditors’ acceptance of an unreasonable deal, ”said Sonam Chandwani, Managing Partner of KS Legal and Associates.

Creditors are losing patience as many cases have been going on for a long time. The IBC states that the resolution process must be completed in 270 days. However, data from the IBBI shows that 79% of ongoing cases are over time. “The IBC intended to speed up the corporate insolvency process; nonetheless, the delay caused by the litigation crept into the process, ”Chandwani said.

In the early years of the IBC, some large NPAs, like Essar Steel and Bhushan Steel, were resolved and creditors recovered a good chunk. In the Essar Steel case, for example, the lenders recovered 92% of the receivables of 49,000 crore rupees.

One of the reasons for the current poor recoveries is that many underlying assets have lost value over time. “Any buyer who comes in is buying for current value and not for the value the banks have on their books,” said Tarun Bhatia, managing director and head of South Asia for Kroll, a provider of services related to the evaluation, governance and risk. . “What is open with the banks is not a contribution to the valuation itself. If a certain company has lost its fundamental value, then the buyer will only pay for certain benefits.”

Videocon, for example, had acquired Thomson’s color picture tubes business a decade ago, which will be of little value to a buyer today as most countries around the world have switched to LCD televisions. and LED. In the case of Jet Airways, most planes were leased and offices were leased. The slots she had ordered had also been allocated to other airlines.

Some of the NPA accounts were also declared fraudulent by banks, where there was usually a disconnect between assets and loans. “A buyer will only offer to pay this amount based on the actual assets on the land and the usefulness of the assets to him. If an entity has borrowed Rs 100 and the assets are only worth Rs 50, then you cannot expect the buyer to pay more than Rs 50, ”said Jindal Haria, director of India Ratings and Research.

Experts say to avoid huge discounts, lenders should start the insolvency process early when a struggling business is still operating. In this way, there are chances that the value of the asset can be maximized. In addition, analysts say lenders should monitor how loans have been used by businesses.

The IBC was a step in the right direction. But changes may well be needed to make it more effective.