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NPAs: Cleaning the rot in India's financial sector

On June 18, the Union Cabinet decided to promulgate an ordinance for the securitisation of assets of banks and financial institutions.

Earlier, on May 7, the Cabinet had decided that the government would introduce a bill called the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Bill, 2002, during the Budget session of Parliament.

This bill was, however, not introduced due to 'paucity of time.'

Whereas the contents of the ordinance are not known, what has not come a day too late is the realisation that the burden of non-performing assets of banks and financial institutions - in lay language, loans that have not been repaid - would completely cripple and paralyse the working of India's financial system, that is, unless the problem is tackled quickly and head-on.

It would, perhaps, be premature to praise the government before the fine print of the ordinance has been scrutinised.

But one can only hope that the issue of NPAs would be dealt with in a bold manner and not in a piecemeal or hesitant fashion. When heart surgery is the only way out for a patient, administering small doses of aspirin would hardly help.

Let us first consider what is known so far about the ordinance. The ordinance, according to Union Law Minister Arun Jaitley (who spoke to journalists after the Cabinet meeting), aims at putting in place a framework for the enforcement of security or foreclosure norms - essentially a mechanism to enable banks and FIs to sell the assets of wilful defaulters, namely, those who have obtained loans but are deliberately refusing to repay these.

The ordinance would enable banks and FIs to create a market for the securitised assets and this would help them manage their liabilities, Jaitley said, adding that the ordinance would assist banks in taking possession of securities, selling these assets or appointing receivers pending such sale.

"This step is necessary to tackle the problem of NPAs…and will mark major reforms in the financial sector," Law Minister Jaitley remarked.

Incidentally, the bill on the subject had been referred to the standing committee attached to the ministry of finance and it was not clear how long the panel of MPs would take to deliberate on the provisions of the bill before it was introduced for enactment by Parliament.

The government now hopes the ordinance route would expedite the passage of the bill during the coming monsoon session of Parliament.

The ordinance also aims at setting up asset reconstruction companies that would take over the NPAs of banks and FIs.

The ordinance would keep certain kinds of NPAs out of the ambit of the ARCs: these are agricultural loans of amounts up to Rs 100,000.

Such loans have been exempt for two reasons: first, these loans cannot be mortgaged and secondly, the government does not apparently want recovery agencies to be seen to be "harassing" small farmers.

The ARCs are meant to take over the NPAs of banks and FIs at a discount to help the latter clean up their books of account, while the foreclosure laws would aid banks and FIs to attach the properties of defaulters.

Securitisation of assets would assist banks and FIs to raise additional funds.

The ordinance is expected to provide over-riding powers to ARCs to impound and encash assets and, if necessary, change the managements of sick companies if they do not cooperate or refuse to pump in additional funds to improve the viability of the ailing firms.

The world over, ARCs not only relieve banks of bad debts in their books but also take on the responsibility of chasing defaulters to recover and collect dues.

In addition to empowering the ARCs to sell the assets of banks and FIs that have been taken over at negotiated discounted prices, a clause in the ordinance would check delays through 'misuse' of legal procedures and processes in order to facilitate early recovery of dues.

Banks and FIs have been so far been fighting lengthy legal battles to recover their dues. The passage of time often results in a sharp deterioration in the quality of assets.

The government has already announced that the first ARC would be formed with a capital base of Rs 3.50 billion. In his Budget speech delivered on February 28, 2002, Finance Minister Yashwant Sinha stated that 'a pilot ARC would be set up by June 30 with the participation of public and private sector banks, FIs and multilateral agencies'.

Sinha added, "This company would initiate measures to take over NPAs in the banking sector and also develop a market for securitised loans."

But many details about the ARC are not yet known. For instance, it is not clear what the exact ownership/shareholding pattern of the company would be. One suggestion is that the ARC should be a trust in order to avoid payment of stamp duty when assets of banks and FIs are transferred to it.

Then, there are a host of issues relating to the administration and management of ARCs that are yet to be worked out.

Special administrators who are appointed have to be upright, honest and transparent - their powers, duties and obligations have to be clearly specified.

To ensure justice, protection of third party rights as well as the interests of creditors (secured and unsecured), it has been suggested that independent advisors or committees of advisors be appointed to review the proposals of administrators.

Another important - and possibly contentious - issue relates to valuation of assets and fixation of realisable values of assets.

These values need to be arrived at in a completely transparent manner. Such values should be fair discounted prices in the opinion of valuers acting on behalf of the concerned banks or FIs as well as the ARC.

Vesting certificates would have to be provided to the ARC to enable it to acquire rights, titles and interests of the assets subject to claims disclosed before a particular vesting date.

At the same time, the officers and employees of the ARC need legal protection for acting in "good faith" so that court injunctions do not stymie their functioning.

Finally, the Union government needs to dissolve the Board for Industrial and Financial Reconstruction - it makes no sense if the ARC becomes an avatar of the BIFR - and abolish the Sick Industrial Companies Act.

It has been further suggested that the government should simplify the rules and provisions of the Income Tax Act for treatment of bad debts, besides carry forward of losses and business income in the hands of the ARC.

How serious is the problem of NPAs? And why is a long-term solution to the problem of recurring and growing NPAs so crucial for the revival of the Indian economy? Let us first look at the sheer dimension of the problem.

According to official statistics, the total value of NPAs of banks and FIs in the country was close to Rs 720 billion at the end of July 2001. However, this is a gross underestimate for a number of reasons.

First, the Rs 720-billion figure excludes the NPAs of private banks and foreign banks. Also, the NPAs of large public sector organisations like the Life Insurance Corporation, the General Insurance Corporation and its four subsidiaries are not known as the current laws of the land permit such organisations not to disclose their bad loans.

If such bad debts were to be included, the figure would easily cross the Rs 1,000-billion mark - in other words, the gross NPAs in the country's financial system are equal to roughly one-twentieth or 5 per cent of India's gross domestic product.

This simply means that one rupee out of every Rs 20 in the national income is accounted for by loans extended by banks and FIs that have not been repaid.

But wait? Even this stupendously high figure of total NPAs is an under-estimate! With effect from March 31, 2001, the Reserve Bank of India has defined an NPA as an advance where the interest and/or the instalment of the principal loan amount remains overdue for a period of more than 180 days or around six months.

The RBI and the government has further stated that "in order to move closer to international best practices and to ensure greater transparency, the duration of treating an asset as an NPA is proposed to be reduced from 180 days to 90 days with effect from March 31, 2004" (Economic Survey, February 2002).

This means that if Indian banks and FIs had to adhere to international norms, the absolute quantum of NPAs in the system would perhaps have doubled.

That's not all. A number of banks and FIs have been blatantly indulging in a practice called 'evergreening' that is not merely frowned upon but just not allowed in many developed countries.

'Evergreening' is essentially a method of sanctioning and disbursing new loans to enable a debtor to repay old loans. The Flex Industries group promoted by Ashok Chaturvedi and the Essar Group of Companies controlled by the Ruia brothers are only two among the many corporate groups in India that have been recent beneficiaries of evergreening.

The RBI too has not been all that innocent despite the fact that India's central bank and apex monetary authority periodically fulminates against banks and FIs when NPAs rise and repeatedly exhorts them to lower their bad debts.

Last year, the RBI relaxed its norms and allowed banks to classify bad loans that had been 'restructured' with an infusion of fresh funds as 'standard' provided the concerned promoters receiving these loans had adhered to the new loan repayment obligations for one year.

Earlier, the time limit used to be two years.

As far as tackling the huge problem of burgeoning NPAs is concerned, what the government has done so far is merely tinkered with the frills and barely touched the tip of the iceberg. A few examples would illustrate this point.

In July 2000, the RBI started a "simplified, non-discretionary" mechanism for recovery of NPAs with outstanding balances of up to Rs 50 million in each account. This "one-time" scheme expired on June 30, 2001, with 27 public sector banks recovering a sum of around Rs 26 billion from some 365,000 accounts.

According to Finance Minister Yashwant Sinha, public sector banks recovered Rs 128.60 billion in 2000-01 compared with Rs 98.83 billion in the previous year.

He added in his Budget speech that till September 30, 2001, the 29 debt recovery tribunals and five appellate tribunals had disposed of 18,703 cases 'involving' Rs 140.26 billion. However, the recovery made was a relatively piffling Rs 35.27 billion.

Compare the recovery amounts to the figure of more than Rs 170 billion of taxpayers' money that the government of India has spent over the last ten years or so to 'recapitalise' various public sector banks, including UCO Bank, Union Bank of India and Allahabad Bank.

It is estimated that close to 15 per cent of the assets of the largest FI in India, the Industrial Development Bank of India comprises NPAs. The situation is much worse in the case of the Industrial Finance Corporation of India.

Between 1999-2000 and 2000-01, IFCI's income came down slightly from Rs 28.99 billion to Rs 28.90 billion, but its profitability came down dramatically.

From a net profit of Rs 593 million in 1999-2000, IFCI incurred a loss of nearly Rs 2.66 billion the following year.

How did this happen? Answer: NPAs.

In 1999, an inspection report of the RBI rapped the IFCI management for not classifying loans advanced to Koshika Telecom (in the group headed by Vinay Rai) as an NPA.

In the middle of 2001, another RBI inspection report claimed that IFCI's NPAs are more than 150 per cent higher than what had been officially declared.

It is learnt that till the end of 2000, IFCI had loaned as much as Rs 14 billion to some 400 sick companies.

The story is no different in a number of other banks. A 129-page booklet brought out by the All India Bank Employees' Association documents 1,300 troubled corporate loan accounts including those of Lloyd Finance, Onida Savak, Pentafour Products, Garware Nylon and J K Synthetics.

The fact of the matter is that India's financial system is extremely opaque and there is an urgent need to make the public aware of the activities of banks and FIs.

Since 1998, the RBI has been putting up a list of wilful defaulters on its Web site - www.rbi.org.in.

The list of defaulting promoters is a virtual who's who of the country's chambers of commerce and industry associations.

It is believed that roughly half of the NPAs in the system have been the creation of well-heeled promoters. As the oft-repeated saying goes: in India, promoters never fall sick, only their companies do.

From time to time, political leaders - including the finance minister - fume and fret and claim that defaulting businessmen would be placed behind bars. But little has actually happened on the ground.

The ordinance to rid the banking system of bad debts is just the beginning. Much remains to be done.

The author is Director, School of Convergence @ International Management Institute, New Delhi and a journalist with 25 years of experience in various media - print, Internet, radio and television.

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