Banks can rescue sinking businesses

It is an axiom in turnaround management that the earlier a firm’s decline is identified, the easier is the turnaround. Of course, that is easier said than done. Every firm has its ups and downs and when it has its downs, management resorts to actions to plug the losses, raise revenues, cut costs and so on to bring it back to its growth path. That is ‘normal’ management. However when the standard operating procedures do not work, then you begin to learn that it is not a normal situation and more drastic steps are required.

Managements usually have a tendency to place all the blame on external events in a decline situation. The government policy, exchange rates, flood of imports and so on, all assume the role of devils with horns out to ruin the firm. The internal evaluation of deficiencies takes a back seat.

Thus, it was quite perceptive of Indian Finance Minister P. Chidambaram, in a recent address to the banks, to call upon them to hold the hands of firms in trouble from difficult external circumstances, and also deal sternly with those who are wilful defaulters. We can loosely interpret ‘wilful’ as not only those who are up to mischief in their operations, but also those who do not properly diagnose the problems facing the firm.

How banks in US do it

The US has one of the most liberal laws to deal with bankruptcy. Called the Chapter 11 of the Bankruptcy Code, the process it encourages should more appropriately be called ‘restructuring’ rather than bankruptcy; the firm does not have to show its assets to be less than liabilities to take advantage of filing under these provisions. In brief, a firm seeks the protection of the court from its creditors while it works out the terms of loans and payments due. The court forms a creditors’ committee that must approve the rehabilitation plan filed by the company. Creditors may have to re-schedule debt and take a haircut in the process. However, after the plan is approved, new loans are forthcoming since they get superior status and lenders are willing to lend again. The management is left in place to execute the approved plan and there is no external agent appointed such as a receiver or a trustee.

In my study of the role of banks in monitoring their small to medium clients in the US and Canada, I found that the banks played a valuable role in early recognition. They usually received quarterly reports from their borrowers, which helped them monitor performance. As the banks had several other clients in the geographical area, or similar lines of business, they would ‘hear’ market news, such as the problem firm’s delayed payments to vendors, a high turnover of workers, or key senior people quitting.

These are all early warning signals. They would enable the bank to raise difficult questions to the borrower to make them re-think their arguments to explain declining performance.

Some tough handholding

It is good to begin thinking in terms of internal and external reasons for decline and to tackle them. A more sophisticated approach would be to classify the reasons as operating and strategic. The operating reasons for decline would be related to functional areas, such as the need for balancing equipment on the shop floor, or poor costing systems that prevent the firm from recognising and allocating costs appropriately to various products and services.

The strategic reasons for decline are the more serious ones. The firm may have lost the valuable competencies that prevent it from being an effective competitor. Its product development may be lagging (remember Nokia?), or the product/market may have become commoditised and cut its margins (IBM in laptops), and so on.

This is where the handholding by the bank needs to be tough. Rather than wait till the asset becomes non-performing (NPA), the bank can push the firm by raising tough questions, bringing in outside experts and forcing the firm to deal with its strategy problems.

However, just because the bank is in a good position to serve as an external trigger for recognition of a firm’s problems, it does not necessarily mean that it will always do a good job.

The loan officer may not have sufficient managerial skills to take a look at the firm’s performance and institute interventions, and may require additional training.

A firm in decline poses various challenges in the effort to turn it around. When a firm’s management finds sufficient external reasons to complain about, stakeholders worried about their stake in the firm become active and attempt to intervene. They typically become active at the stage of debt restructuring, when it may be too late.

Especially for small and medium enterprises, banks are uniquely positioned to play a constructive role in the recognition process. When the firm is functioning normally, they need to maintain a distance.

However, under conditions of decline, they need to step forward to take the lead and, in the selfish process of protecting their interests, find ways to help the firm become a performing asset.

(The author is a professor and dean of the Jindal Global Business School, Sonepat, Haryana.)

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