RBI identifying defaulters for insolvency can hurt banks’ balance sheets

Empowered by the new NPA ordinance, the RBI on Tuesday went into fire-fighting mode, identifying 12 big defaulters for insolvency.

The RBI’s Internal Advisory Council (IAC) recommending these accounts — constituting a fourth of the system’s bad loans — for immediate resolution is no doubt welcome. But given that these are large accounts and failure of a resolution plan could result in huge haircuts for banks, the plan still sounds good only on paper.

Banks may end up taking a 80-90 per cent haircut in some cases, if the company goes into liquidation (on failure of resolution), according to bankers and market players.

Banks will appoint lawyers to oversee the insolvency process, who in turn will hire insolvency resolution professionals to initiate the process through an application filed with the authorities. The authority, in this case, is the National Company Law Tribunal (NCLT). The resolution professional would call upon all the creditors to submit their claims. Subsequently, the professional would assess the financials of the borrower, claims, and the amount of assets available to settle the claims.

“The resolution plan is then drafted, which could include a turnaround fund investing money in the company if there is still some potential. Or, it could be in the form of an ARC investing in the company or a strategic buyout, wherein a competitor steps in to buy the assets of the company,” says Neha Malhotra, Executive Director, Nangia & Co, a tax advisory and tax consulting firm.

On failure of the resolution plan or if majority of the creditors do not agree with the resolution, the company would go into liquidation and banks could end up recovering only a small amount.

Some bankers believe that the assets could be obsolete and not in working condition, and so the realisation would not be much. Also, given the huge supply of assets and few takers, sale may not happen that quickly.

“The assets will be sold and the realised amount will be distributed to stakeholders — liquidators and insolvency professionals (fees), secured creditors and workmen, employees, government dues, etc., in that order,” says Neha.

Also, while resolution is time-bound — 180 days with 90 days extension — liquidation could take even two to five years. The value of the underlying assets by then could come down significantly.

Hence, the success of a resolution plan (or avoiding going into liquidation) will be critical for banks, to ensure that they recover some reasonable amount from the account.

This should nudge banks to right-size their debt, says Nirmal Gangwal, Managing Director, Brescon Corporate Advisors, a corporate debt restructuring advisory firm.

In finding ready takers for businesses or selling bad loans to asset reconstruction companies, lack of concurrence of the serviceable portion of debt has impeded resolution. A time-bound approach, along with the pressure to resolve these accounts, can hasten the process this time around, adds Gangwal. The downsizing of loans could attract potential buyers for these stressed entities.

Many, however, believe that the 12 accounts being referred to for insolvency may have already gone through various restructuring schemes such as CDR, SDR or S4A.

Failure under these schemes could have nudged the RBI to refer them to the Insolvency and Bankruptcy Code 2016. Hence, resolution could once again hit a roadblock, triggering the liquidation process.

Banks with high levels of bad loans and weak capital may see some more pain in the coming quarters, given the high level of provisioning requirement on account of huge haircuts.

As of March 2017, IOB, IDBI Bank, Central Bank and UCO Bank have the highest levels of gross non-performing assets. IOB, for instance, has a GNPA of 22.3 per cent while IDBI Bank’s bad loans are 21 per cent of its total loans.

These banks also have a weak capital position, with Tier I capital around the 8-8.5 per cent mark. Unless the RBI offers some leeway in provisioning, such as apportioning it across several quarters, banks’ capital could weaken further.

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