There are five theories for why Indian banks recover so little of their bad loans. The first suggests something cultural about repayment intentions of Indian borrowers. This is, at best, the soft bigotry of low expectations and, at worst, racism. The second theory suggests that many big bank loans are a child of political connections; this smells right.
The third theory suggests that many large Indian projects are gold-plated; indeed, many seem to have spent more money than needed. The fourth theory suggests that Indian banks have not really been making loans but equity masquerading as debt. The fifth theory — probably the most important — suggests the lack of a speedy and decisive bankruptcy process became an unfair advantage for large borrowers. Bad loan recovery will not improve immediately; some companies going bankrupt now first defaulted 15 years ago, so recoveries should be compared to zero. But the ongoing reboot of our bad loan handling regime — revealing, recognising and resolving — will enable higher future recovery rates, modify entrepreneurial behaviour, and lower future incidence of bad loans. Let’s look at the 3 R’s.
One, resolving. The Insolvency and Bankruptcy Code (IBC), a competent Insolvency and Bankruptcy Board (IBBI), and Bank IBC filings mean that Rs 3 lakh crore loans are under resolution. Some process tweaks are needed but a new Insolvency Law Committee is detailing them. The recent decision on eligibility for bidders was important because of the practically non-existent track record of repeated in-situ restructurings. More importantly, we don’t live in an economy but a society; the sustainability of big changes depends on their fairness.
Two, recognising. India is one of the 160 countries to sign up IFRS 9, a new international accounting standard born of the policy feeling that banks recognised bad loans too little and too late in the global financial crisis. IFRS 9 has three stages. A small provision is made when a loan is made for expected losses over the next 12 months. But this provision can rise quickly to the expected lifetime loss of the loan in two phases with borrower credit risk changes. Previously, loans to risky borrowers with higher interest rates meant higher bank income but no provision if creditworthiness declined. This complex change will be phased over five years, but the RBI’s Asset Quality Review, without changing rules, has already required banks to provide Rs 4.54 lakh crore extra for bad loans.
Three, revealing. Banks, globally, improve recovery rates by “calling” loans (all future payments become due) immediately after the disclosure of payment misses or lower-case defaults (violations around information, ownership, liquidity or operational covenants). Revealing defaults forces open lines of communication, enables good faith negotiation between borrowers and lenders, and shrinks the extended bankruptcy periods that destroy value. A good bankruptcy regime does not aim for liquidation but motivates a speedy renegotiation of financial viability if there is operational viability; this needs immediate, automatic and universal disclosure.
Doctors know that emergency room medicine is triage followed by quick, invasive and expensive procedures. But if the patient comes to the emergency room regularly, they need to lose weight and eat better. Current bankruptcy changes represent triage but are complemented with preventive measures from the RBI like capping exposures to companies and sectors, disclosing provisioning divergence, prompt correction action framework, a central repository of information on large credits (CRILIC), and a mandatory legal entity identifier in CRILIC for all borrowers of more than Rs 1,000 crore by March 2018 and more than Rs 50 crore by December 2019.
Two areas need more work: Governance at public-owned banks (Aristotle warned that when everybody owns everything, nobody takes care of anything) and revealing defaults (sunshine is the best disinfectant). A great new book Capitalism without Capital by Jonathan Haskel and Stian Westlake suggests the rise of intangible assets makes corporate banking riskier; the Rs 2.1 lakh crore nationalised bank recapitalisation must come with surgery to their business model (no big corporate lending), culture (capping growth rates), and accountability (governance). The second area of revealing defaulters needs reconciling conflicting legal, regulatory, liquidity, privacy, and fairness questions. But automatic, immediate and universal disclosure should be a goal reached through interim filters for timing (a small lag) and materiality.
The wilful defaulter definition needs review; it’s a flawed application of the legal concept of mens rea (meaning intention or state-of-mind and implies differentiating between murder and death by car accident) because loan taking and giving is by definition risk taking with a range of outcomes including default, restructuring and repayment. We need one definition of default, SEBI’s smart proposal for listed company defaults must be reinstated, and IBBI’s information utility activated. China’s solutions are unacceptable — being listed on the government website of defaulters last week means that Jia Yueting, the founder of $3 billion consumer electronics firm LeEco, can be restricted from using luxury hotels, private schools, golf courses, and airlines. But India’s status quo of even a loan classified as bad often not being known outside the bilateral relationship needs change.
India’s Rs 10 lakh crore bad loans are also a child of the breathless bank loan expansion from Rs 18 lakh crore to Rs 52 lakh crore in the six years before 2014. The decisive actions by the current RBI management team on bad loans break with its immediate institutional past by shifting from a personality cult to institutional solutions.
The over-intellectualisation and running academic commentary masked years of inaction on bad loans that deserve Poet Akbar Allahabadi’s quip “Platoen ki awaaz bahut der se aa rahi he, lekin khaana nahin aa raha he (The sound of plates has been coming for a long time but the food is not coming)”. A banking system that recovers its loans is an important part of India’s infrastructure of opportunity. The contours of this system are emerging.