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Forbearance over Default

Danger of Misuse

C P Chandrasekhar (cpchand@gmail.com) is with the Centre for Economic Studies and Planning, Jawaharlal Nehru University, New Delhi.

In a move ostensibly aimed at helping micro, small and medium enterprises hurt by demonetisation and the goods and services tax regime, and burdened with distressed debt, the Reserve Bank of India acceded to the demands that a lenient regime of debt restructuring should be put in place. However, the evidence suggests that this would not go very far in helping the units in this large sector. This gives rise to the suspicion that the real intent of the move is to open the door to a return to a regime wherein bad debt, resulting from default on debt service by large corporate borrowers, is restructured at the cost of the taxpayer.

In response to pressures from the government and its nominees on the board, the Reserve Bank of India (RBI), under the leadership of a new governor, has decided to step back. Departing from its insistence that restructured loans should not be treated as standard assets, the RBI has issued new guidelines that allow for the restructuring of loans subject to default, provided to micro, small and medium enterprises (MSMEs) with total (fund and non-fund) exposure of up to ₹ 25 crore. As part of what is being termed as a one-time concession, stressed loans that have not been declared non-performing as of 1 January 2019, can be, subjected to restructuring before March-end 2020, without them being downgraded in status to non-standard assets. As part of this diluted restructuring process, banks and non-banking financial companies (NBFCs) are required to make a provision for 5% of the value of the assets so restructured.

There is much that can be said in support of such a measure. The MSMEs, which are in any case more vulnerable than large firms, had been badly hit by both demonetisation and the hasty implementation of the badly designed goods and services tax (GST). One consequence of such damage is the difficulty in repaying loans, and the pressure from the government to ease the terms of restructuring of MSME debt is a recognition of the effect its own policies have had on units in the sector. Easier restructuring, it is hoped, would keep credit flowing to these enterprises.

For a now-chastised RBI, this is of course low-hanging fruit in terms of acceding to the government’s demands. Much of the debt taken by the MSMEs is from the informal credit market and does not involve institutions under the central bank’s regulation. According to the 2018 MSME Pulse report released by the TransUnion CIBIL and the Small Industries Development Bank of India (SIDBI), credit from the formal financial system to the MSME sector was at ₹ 11.75 lakh crore, which is only a small proportion of the total credit outstanding of almost ₹ 100 lakh crore. Just 50 lakh of the over 5 crore MSMEs had accessed the formal financial institutions for credit. Despite being an important source of formal funding, micro and small enterprises account for a relatively small share of scheduled commercial bank (SCB) credit as well as past and potential non-performing assets (NPAs). Business loans of ₹ 25 crore or less to non-farm enterprises (other than individuals) amount to only around 13% of the outstanding credit. And, at the end of March 2018, MSMEs accounted for 9.5% of the NPAs of the SCBs, down from 11.4% a year earlier. Even if their share in new defaults was rising, it is unlikely that such defaults would be of a magnitude that would hurt the banks as much as the non-priority NPAs amounting to 78% of the total.

Seen in this light, the RBI’s restructuring concession does, at most, limited justice to a stressed sector suffering from the adverse consequences of the government’s own policies. Unlike the waivers of distressed farm debt resulting from neglect of and discrimination against the agricultural sector being implemented in some states, the loan here is not being written off. All that is being done is giving banks and NBFCs the option of restructuring stressed debt, which is likely to have a relatively small impact on the banks’ balance sheets. The RBI’s earlier reticence to accept the government’s demand was not so much because of the damage it would do to the banking system as the violation of the principle, that restructured debt would be treated as standard. This it had established in the face of strong opposition from big businesses and its supporters in the government.

However, this violation of the principle starting with what seems to be a more or less innocuous concession to banks lending to small producers, could have larger implications. What is at issue is whether this return to “painless” restructuring would be once again extended to large corporate borrowers who account for the bulk of the NPAs. In the past, it was these borrowers who benefited from restructuring, through the corporate debt restructuring cell and other special schemes. Restructuring involved extending the repayment term, reducing interest rates, converting part of the debt into equity (so as to reduce the interest payment burden) and offering additional credit. Once restructured, the stressed assets concerned were treated as restructured “standard” assets. Until financial liberalisation and government prodding encouraged banks to diversify into risky lending to capital-intensive projects, including in infrastructure, default was seen as either the handiwork of wilful defaulters or the consequence of the “populism” that forced banks to lend targeted sums to the priority sector. But, that was in an era when priority and non-priority sectors contributed equally to the NPA burden of the SCBs. But now, the non-priority sector accounts for three-fourths of the NPAs. As the corporate share of bad loans rose, the argument advanced was that this was the result of a bad investment environment, to cope with which restructuring had to be encouraged, and restructured assets treated as standard assets to keep credit flowing. Land acquisition difficulties, slow environmental clearances and changed economic conditions were blamed for default, rather than mismanagement or plain fraud.

Fraudulent Transactions

The resolution process under the Insolvency and Bankruptcy Code (IBC), 2016 involving scrutiny of books by resolution professionals has revealed that it is not the external environment, but fraud that had paid a major role in cases of default. According to Subramanian (2018), evidence of fraudulent transactions totalling ₹ 40,000 crore has emerged from more than a 100 of the companies under resolution. Allegations of fraud have been made even with regard to some of the early “big” cases of default such as Jaypee Infratech and Bhushan Steel.

It was only recently that the RBI decided that the post-liberalisation forbearance, with respect to defaulting borrowers, amounted to concealing bad assets and postponing a problem that needed resolution. To correct that, it pushed through an asset quality review that forced recognition of bad assets at an early stage which, after the passing of the IBC, were subjected to a faster resolution process. The experience with the IBC so far has been mixed. According to the RBI, by the end of March 2018, 738 cases had been referred to the National Company Law Tribunal (NCLT). Of these, only 21 cases had their resolution plans approved. A substantial amount of disputed debt was resolved at the pre-admission stage, suggesting that recalcitrant promoters, realising that they could lose control or be subject to scrutiny, chose to settle. The average recovery in these cases amounted to 49% of the ₹ 9,900 crore debts in question. Though the average recovery rate was better than under channels such as the Lok Adalats (4%), Debts Recovery Tribunals (DRTs) (5.4%), and Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest (SARFAESI) Act, 2002 (24.8%), the loss or haircut involved is still large for the banks, and the number of resolved cases has remained low and the pace of resolution much slower than expected. Part of the problem is the reticence of even the banks to move the process to liquidation, since that would, in all likelihood, involve a substantial haircut.

Meanwhile, provisioning requirements, even when the NCLT process is on, is hurting bank profitability and their capital adequacy ratios, necessitating further rounds of recapitalisation. To avoid having to meet a large recapitalisation bill, the government too is looking to keep resolution and liquidation to a minimum. This increases the attraction of the earlier regime under which the problem could be temporarily done away with through restructuring and the treatment of restructured stressed assets as standard assets.

The theory that large corporate defaults are the result of extraneous circumstances like clearance obstacles or poor economic conditions sounds ominous in this context. If big business is absolved of direct responsibility for default, they cannot be brought to book. As the MSMEs have been helped by the return to a more lenient debt restructuring process, the large corporations may also appeal for and obtain special treatment. That leaves the banks holding the bad but “restructured” debt. When the problem cannot be postponed any further, their balance sheets are damaged till the government finds the required money for recapitalisation.

In actual fact, there is no case for leniency in restructuring and a strong case for resolution and investigation of suspect transactions. But, the government’s big business-friendly stance does raise the possibility that the concession offered with respect to restructuring of MSME debt on the grounds of them having been forced into defaulting on debt service may be extended to big corporations as well. In an environment wherein evidence of cronyism is rife, this is definitely a possibility.

Reference

Subramanian, N Sundaresha (2018): “Fraud Cases under IBC Crosses Rs 40,000 Crore,” Economic Times, 30 September, https://economictimes.indiatimes.com/news/economy/finance/fraud-cases-under-ibc-cross-rs-40000-crore/articleshow/66015840.cms.

Updated On : 11th Jan, 2019

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