Tackling the bad debt problem


Over the past five years, considerable progress has been made in resolving and collecting bad debts from banks. Despite this, there are still around Rs 10 lakh crore of stressed assets lying around in the system. The newly formed National Asset Reconstruction Company (NARCL) in the public sector offers hope for a faster cleanup of lenders’ balance sheets. It would be the 30th Asset Reconstruction Company (ARC) in distressed asset resolution, but the first in the public sector.

Its greatest virtue lies in the faster aggregation of distressed assets that are scattered among several lenders. Second, its securitized receipts (SRs) come with sovereign insurance. This particularly reassures PSU banks, as price discovery would not be the subject of further investigation. It would initially focus on large accounts with debts over Rs 500 crore. It should also free banks from the torturous recovery process and give them more room to focus on much needed credit expansion. The newly created ARC, NARCL is not a bank, but a financial institution specializing in helping to resolve banks’ distressed assets.

While debt aggregation is undoubtedly a distinct advantage, will it provide better and faster results for lenders in terms of fulfillment? The proof of the pudding lies in the execution and all eyes will be on the IDRCL (Indian Debt Resolution Company), the operating arm, which is said to be in the private sector. Can this public / private partnership make a difference?

Over the past three decades, several institutional and policy measures have been taken to resolve bad debts. Institutional measures include BIFR (Board for Industrial and Financial Reconstruction, 1987), Lokadalat, DRT (Debt Recovery Tribunal, 1993), CDR (Corporate Debt Restructure, 2001), SARFAESI (Securitization and Reconstruction of Financial Assets and Enforcement, 2002), ARC (Asset recovery company, 2002). But the resolution for the latter is 6.2%, 4.1% and 26.7% respectively for Lokadalat, DRT and SARFAESI. The RBI also launched a series of measures during 2013-14 to resolve, rebuild and restructure stressed assets. These also did not deliver and they were all subsequently abandoned. The RBI has again released a prudential resolution framework. A poor ecosystem and legal delays frustrate many of these initiatives. These need to be dealt with.

Of the 28 CRAs (private sector) in activity, many are bit players. The top five ARCs represent over 70 percent of assets under management (AUM) and nearly 65 percent of capital. Either they should consolidate or develop strategies as niche or regional players. Even private sector CRAs have not been successful in selling zombie assets. Barely 13.9% of the assets acquired are actually sold. Financial and business restructurings seem to be more of the exception than the norm. Almost a third of debts are rescheduled. This is not much added value to what lenders would have done otherwise at no additional cost. (See table 1)

Source: RBI Reports

The IBC, introduced in 2016, was landmark legislation and marked a welcome departure from previous measures, with a legally time-limited resolution. The emphasis is on resolution rather than recovery. Qualitatively, this instilled a sense of fear in the evil corporate borrowers who siphoned off funds and dethroned them. It almost ended eternity. Even if there are delays in this new promise, they are counted in terms of days, not years and decades. He managed to resolve a few large corporate borrowers with an average recovery of 45%. But there is concern about high haircuts – in some cases up to 95 percent.

The NCLT (National Company Law Tribunal) turns out to be the bottleneck. It is the backbone of the IBC, but it is woefully lacking in infrastructure and more than 50 percent (34 out of 63) of the NCLT benches were deprived of regular judges. More than 13,170 cases involving troubled debt of Rs 9.2 lakh crore languish with the NCLT. Even the parliamentary committee was rightly outraged by a large number of vacant posts. This lack of adequate infrastructure, coupled with the poor quality of its decisions, has proven to be the Achilles heel of the IBC. We need judicial reforms for quick and final resolutions.

Forty-seven percent of the cases referred to the IBC, representing more than 1,349 cases, have been ordered into liquidation. More than 70 percent of these cases languished at the now extinct BIFR for years and decades. Against the aggregate claims of creditors of approximately Rs 6.9 lakh crore, the liquidation value was estimated at a paltry Rs 0.49 lakh crore. Lenders and regulators must address this problem of late recognition and resolution. Perhaps lenders’ incentives for more flexible provisioning requirements would encourage them to recognize early. Commercial and / or financial stress must be recognized even before regulatory standards on the NPA classification.

The tendency to make decisions on the basis of the first available information is called “anchor bias”. The first information available in the calls for tenders for assets in difficulty is the acquisition cost for the CRAs. In the case of the IBC process, this is the net asset value by the IBBI appraisers. According to reports, distressed assets that are fully provisioned may be taken over by NARCL at 20 percent. This low acquisition cost would suffer from the anchoring effect and the bias. Potential bidders would offer prices closer to this anchor point. This was observed in the IBC bidding process where in many cases the prices quoted were close to the liquidation value.

Nobel laureate Daniel Kahneman argued that “the anchoring effect is not [a] laboratory curiosity. It can be just as strong in the real world “” When people are faced with a difficult situation, they hold on to the straw[s] and this straw is [the] anchor straw ”. This can be mitigated by “opposing thinking”. He suggests a three-step process to mitigate anchor bias: one, recognize bias; two, seek more and new sources of information; and three, anchor on the basis of new information. Evaluation is a hotly contested issue.

The IBC has made considerable progress in changing the behaviors of wandering and deliberate defaulters by prohibiting them from taking over struggling assets. NARC should defend this principle, not dilute it. Otherwise, the credit culture suffers. Second, it should have a three to five year sunset clause. This will avoid the perpetuation of moral hazard and will also encourage early resolution. Third, anchoring bias must be mitigated through better discovery of extrinsic value. Fourth, he should avoid selling to other CRAs.

NARCL is a welcome initiative. But no number of troubleshooting and recovery tools and frameworks can solve the fundamental problem of accumulating high and recurring APN generation. Prevention of the build-up of NPA (less than 2%) is essential.

The RBI recently published (November 2) a report on the functioning of the CRAs. The report justifies our argument that the performance of CRAs is “poor”. The draft report, inviting the public to comment, makes 42 recommendations to improve the performance of CRAs. This article incidentally attempts to identify some constraints and to propose solutions to improve the performance of ARCs.

This column first appeared in the paper edition on November 22, 2021 under the title “Bad credits and bottlenecks”. Rangarajan is the former Chairman of the Economic Advisory Council to the Prime Minister and former Governor of RBI and Sambamurthy is the former Director and CEO of IDRBT

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