Over the past few years, there has been a large cloud hanging over the Indian corporate sector and the Indian banking system, in the form of the large non-performing assets (NPAs) on the balance sheet of the banks. This has resulted in the impairment of the equity that the banks have on their balance sheet, which in turn severely affects their ability to lend to the economy. The result has been that the economy is growing below potential partly due to inability of the banks, particularly the PSU banks (70% of the banking sector), to lend money to borrowers who require capital for their businesses
The size of the bad debt problem is estimated to be about Rs 8 lakh crore ($125bn) and it constitutes roughly 10% of the banking sector’s advances. Much of the problem has arisen because of the excesses of the 2007 boom and the continuous kicking the can down the road by bank managements. Moreover, the process of resolving many of these NPAs did not have sufficient regulatory backing, leading to an endless resolution process, which neither helped the businesses nor the banks. It is heartening to see the current government take a bold stance of tackling the root of this problem. In May 2016, the parliament passed the ‘Insolvency and Bankruptcy Code’ and it became effective in December 2016. The code establishes the Insolvency and Bankruptcy Board of India, to oversee the insolvency proceedings and the National Company Law Tribunal (NCLT) is the adjudicating authority before which a plea for insolvency can be submitted by the lenders. Once an insolvency plea is accepted, there is a 180 day window (extendable by 90 days) within which a resolution plan has to be drafted. The process is to be managed by licensed Insolvency Resolution Professionals who will control the assets of the debtor during the Insolvency process. Developed markets like the US have the concept of Chapter 11, which can lead to swift resolution of bad debts. A functioning bankruptcy law will not only help lenders to recoup their loans but more importantly save many businesses.
On June 13, the RBI came out with a list of 12 large defaulters which have been referred to the NCLT. A deadline of 180 days has been set for the presentation of the draft resolution plan of these 12 cases, failing which these cases will move ahead towards liquidation. This has been followed up in the third week of August with a second list of 40 more large defaulters against which the banks can initiate insolvency proceedings. Together with the initial list of 12 defaulters this constitutes about 60% of the total non-performing assets in the banking system. The RBI seems determined to get a swift resolution of the NPA problem – this will also prevent NPAs from building up in the future as promoters realise that they can end up losing control of their businesses, if they don’t behave prudently.
Flow of capital is important for the economy to grow – the large NPA issue had clogged up the system preventing banks from lending effectively. The swiftness with which the RBI is acting in this regard is encouraging and we hope that we have a resolution to this thorny problem in sight. More importantly, these steps will go a long way in ensuring future NPAs are fixed quickly rather than fester for several years. An effective addressal of this problem will allow the economy to get the necessary capital to grow closer to its potential.