Bad loan crisis

Bad loan crisis

The introduction of the Insolvency and Bankruptcy Code, the formation of Insolvency and Bankruptcy Board of India (IBBI) and the recent RBI directed bankruptcy-filing recommendations of the 12 largest defaulters is a landmark and welcome step towards the speedy resolution of the bad loans crisis, which has been festering (बुरा होना/बेकार होना) for years. Certainly, over time an adjudicating authority like the National Company Law Tribunal (NCLT) along with an empowered bankruptcy administration like IBBI will be able to resolve most of the ordinary bankruptcy cases. However, for now the greatest challenge is the ability of a fledgling (a person or organization that is immature, inexperienced, or underdeveloped.) IBBI to handle complex and large bankruptcies, and more important, for our political-economic system to craft a solution to the larger unanswered question of how our banking and financial system is going to absorb the ensuing (आगामी) multi-billion dollar debt write-downs as a result of these bankruptcy resolutions.
Unfortunately unlike ordinary cases, the bulk of the non-performing loans are concentrated in a few borrowers, with ten companies owing more than $6 billion a piece and 50-companies accounting for more than 70% of the debt. Our estimates, based on restructuring analysis of over $20 billion of assets in the steel sector alone, show that the largest stressed assets will need to take debt write-offs to the tune of 50-60% before their cash-flows can start supporting interest payments and lay a viable (विकासक्षम) (and credible) reorganisation plan for the company.
A working and implementable bankruptcy code should try to successfully resolve these stressed assets while preserving maximum economic value through restructuring and change of control and it should not degenerate into a mechanism for liquidations. Contrary to popular beliefs in our country, bankruptcy is not, and should not be necessarily construed (interpret (a word or action) in a particular way) as an instrument for liquidation. This means that the bankruptcy ecosystem needs to have competent insolvency resolution professionals with deep industry, business, technical, operational and organisational expertise and a working infrastructure for information availability and information transparency, so that an economically optimum and socially prudent outcome can be engineered. Liquidations should, therefore, be used only as the last resort, as large-scale liquidations destroy capital, livelihoods, communities and social and organisational capital.
To maximise the likelihood of value preservation, the transition of control in the interim should exercise caution so that operational disruptions and information asymmetries do not erode the value of the firm and the likelihood of its recovery. Unlike the general debtor-in-possession norms in more mature bankruptcy systems, the current bankruptcy code vests immediate transfer of control and management of the debtor assets to the interim resolution professional through the creditor initiated filings. Given the reasonably suspect nature of many of these stressed assets, the motivations for a trustee-in-possession type reorganisation is understandable, but this should not jeopardise the restructuring and recovery of the firm in distress. It is perhaps more pragmatic and prudent to constitute an experienced operating board along with debtor management participation for transition of management control.
Setting up the infrastructure and ecosystem and drawing on expertise from experienced industry, operations, restructuring and bankruptcy professionals to support the complex bankruptcies should perhaps be the immediate priority of the nascent bankruptcy administration. It is all the more important that the right resources and due processes be applied so that the upcoming set of multi-billion dollar bankruptcy cases with the NCLT do not result in consistently adverse outcomes triggering avoidable liquidations, delays and unviable reorganisation plans. This can lead to larger than manageable write-downs, asset destruction and zombie (completely unresponsive to their surroundings.) banks, which ultimately result in “bankruptcy overhangs” affecting the credibility, economic growth, fiscal deficit and the ability to attract new capital.
Bankruptcy resolution of these large assets is likely to result in recognising very large upfront write-downs for the banks for the reorganisation plans to be viable. For example, as consultants to the steel industry, our initial assessments indicate that initial write-downs could be the tune of $20-25 billion in the steel sector alone. If all other sectors are considered then it is likely that recapitalisation required for the banks could run close to $100 billion. As these write-downs are primarily concentrated in a few large public sector banks, it will quickly deplete their capital cushions. Given the magnitude of the recapitalisation required the government would need to recapitalise these banks by issuing substantial securities and/or by privatising bank holdings so that they can start lending. Recapitalisations should also be used as an opportunity to restore distorted incentives by making recapitalisation contingent (subject to chance/ dependent on.) upon bank restructurings and stringent reforms in the banks’ lending and risk management practices. However, recapitalisations need to be carefully calibrated because expectation of large capital commits may incentivise the banks to take excessive write-downs (a reduction in the estimated or nominal value of an asset.), while limited funds might result in non-resolution forcing liquidations leading to even larger recapitalisations. Further, given the current industry down-cycle in steel and power many of the large assets may not find buyers and will likely be deeply discounted or face liquidation, even though they may have significantly higher intrinsic value after restructuring.
Rather than selling at deep discount or disruptively liquidating these large assets with the taxpayer/government paying the bill through recapitalisation, a more orderly transition mechanism that maximises recoveries could be through a thoroughly professional centralised quasi-government interim holding agency. This agency acquires controlling interest in the interim and manages and restructures these assets as they come out of the bankruptcy proceedings. It will then progressively dilute (make (something) weaker in force, content, or value by modification or the addition of other elements.) the controlling interest to the future stewards (प्रबन्धक) and investors of the restructured firm as well as securitise and sell some of the holdings through the capital markets. By the time the centralised interim agency exits the position in these firms most of the bank recapitalisation infusions would likely have been recovered.
Large-scale bankruptcy induced bank recapitalisations should not necessarily cost the taxpayer and the government an arm and a leg (a lot of money). In the well designed Swedish Banking Crisis resolution of the 1990s, the tax-payer paid a modest few percentage points of the GDP at about $1-2 billion and in the badly managed Japanese NPA crisis of the 1990s the taxpayer paid over $200 billion. On the other hand, a well-architected resolution process executed with decisiveness and speed can even make money for the taxpayer. During the height of the US financial crisis of 2008, TARP with a $700 billion commitment was designed to bail out the banks and the auto industry. The US Treasury provided loans and temporarily took control of these companies after bankruptcy reorganisation. By the end of 2015 when all acquired interests by the US government in the entities were sold, the taxpayer made over $15 billion.
There is a saying that capitalism without bankruptcy is like Christianity without hell. Bankruptcy is, thus, a part and parcel of a progressive, dynamic and vibrant industrial society. The crisis at hand is in fact a terrible opportunity to waste. We must use this opportunity to do things right, focus on the right priorities and galvanize (excite (someone) into taking action.) the political will and resolve to take these large bankruptcies to their logical conclusions. We have a good chance that the majority of the firms get restructured and revitalised, the taxpayer comes out whole, banks start lending and the economic growth reignites to touch 8-10% levels over the next few years. With so much at stake (at risk.), failure is not an option.