Unorthodox approach to resolving NPAs

Ajay Shankar | Updated on November 18, 2018 Published on November 18, 2018

At the crossroads Resolving bank NPAs needs out-of-the-box thinking   -  Getty Images

Creating equity funds to take over distressed firms would help banks recover loans and also turn around projects

The scale of bank NPAs and the pipeline of cases moving for insolvency proceedings is staggering. At one end, there is a sense of genuine progress. Indian capitalism is undergoing a qualitative transformation for the better. The cosy nexus between bankers and promoters with no real penalties for non- performance and bad loans is finally coming to an end.

Banks are taking severe haircuts. Promoters are losing control of their companies for the first time. Governance of banks would improve. Companies, after sale through the insolvency process, would have new owners and healthy balance sheets. Others would undergo liquidation, something which has been overdue in India.

At the other end, there is considerable anxiety. Instead of a modest flow of insolvency cases, there is a deluge. Resolution of cases is getting delayed well beyond the stipulated time. The bigger worry is the rising magnitude of losses for the banks. With such heavy write-offs, would the Indian banking system be left with the ability to lend with confidence after due diligence and assessment of risk?

If not, the Indian economy may be in for a more prolonged period of relative stagnation. There are enough examples in economic history of a banking system shock in a country leading to a prolonged periods of tepid economic performance. The hard reality is that there are still no signs of real recovery of private investment in India.

The bankruptcy process assumes normal times, with only some firms becoming insolvent — and enough healthy firms in the market to bid competitively to take over these firms at fair market valuations, with the banks absorbing losses accordingly. The banks would themselves be healthy enough to take such losses in their stride.

But these are not normal times. There are only a few corporates in India with healthy balance sheets and the appetite for take overs. Given the global economic uncertainties and India’s own economic difficulties, there may not be too many foreign entities wanting to bid competitively and take over bankrupt firms and that too at fair valuations.

Further, the sudden greater concentration of economic power in a few large corporates in India, or, large scale take over of Indian firms by foreign entities would not be a desirable outcome.

What would be worse is a poor bidding response leading to write-offs by banks becoming much larger than fair valuations would warrant. In case of no bids and just asset sales, the write-offs would be even larger. These seem realistic scenarios now. The real issue, therefore, is whether this is unavoidable, or, whether anything can be done to minimise bank losses.

Power sector issues

A major share of bad loans is in the power sector. This is one sector where write-offs need not be large. Electricity is an undifferentiated commodity whose demand in India would keep rising over the coming decades. Power plants have a useful life of over 40 years. Conceptually, the write-offs required are not large: the interest burden due to project completion delays, which could be due to financial difficulties of the promoter, or, uncertainties regarding coal supply, and some additional interest burden for the next few years till electricity demand picks up sufficiently.

In some cases, promoters may have gold plated projects and diverted funds and these would naturally need larger write-offs. But sale through the insolvency process is likely to result in very large write-offs, way above what is reasonable. Fortunately, the need for a holistic sectoral solution has been recognised by government and a committee has been set up for this purpose.

One feasible way forward would be to have equity funds which could take over troubled projects at a fair value and then have them completed and run by professional board-managed companies. Banks would also get better valuations and their need for capital infusion from government would decline.

The difficult challenge would be to create such funds. This would need creative leadership from the government, which would have to get public financial institutions to create such funds. Some incentives, such as full tax exemption for initial investment and no tax on capital gains up to seven years, would help in the mobilisation of money from the market, including from retail investors. Such funds should start giving reasonable returns within five years from power projects as electricity demand would have risen sufficiently by then, if not earlier.

This rationale also applies to sick real estate projects. Most developers have assets in land which cannot be monetised now due to the slump in the market. They do not have the resources to complete ongoing projects. Here, the distress of those who have booked apartments is acute.

A role for equity funds

Confiscating assets of directors, or, sending a promoter to prison are punitive measures — but these do not provide a solution. Take over by equity funds at fair market value of incomplete projects and land assets of the developers would provide a solution. The funds could be mandated to complete projects and hand over completed units to those who had booked and made payments through new professional management.

In a few years demand for housing would pick up and the land taken over would get converted into profitable income streams with fresh construction. In other sectors too, such equity funds by being in the market for bidding would help banks get a fair value and keep their write-offs down to reasonable levels.

These equity funds would also usher in the other overdue critical transformation in the Indian economy of having a growing number of professionally-run, board-managed companies in addition to promoter family controlled firms. The few professional Board managed companies such as HDFC, L&T and ITC are outstanding success stories. India could do with many more such firms. These are difficult times which need out-of-the-box thinking and unorthodox solutions.

The writer is Distinguished Fellow, TERI, and former Secretary, DIPP

Published on November 18, 2018
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