Soaring Bad Loans, Abysmal Recoveries Show Bankruptcy Code Is Itself Bankrupt

Only 13% recovery on loan defaults of Rs 10 lakh crore shows that all is not well with the operation of the bankruptcy reforms.

The Reserve Bank of India has disclosed that Rs 10 lakh crore in bad loans have been written off in the last five years. Worse, banks have only been able to recover about 13% of the bad loans from defaulting corporates and other entities. The revelation made to Indian Express in response to an RTI confirms the worst fears ― that the Insolvency and Bankruptcy Code of 2016, touted as a showpiece reform, has failed in many respects. The corporates of course will hail the reform because they have got away with a 87% haircut on their defaulted loans. Some time ago, a prominent Kolkata-based industrialist said exploiting the bankruptcy law was the new game in town and corporates were getting away with 90% haircut on average on defaults. He was pretty close to the actual figure, the RTI reply reveals.

Only 13% recovery on loan defaults of Rs 10 lakh crore shows that all is not well with the operation of the bankruptcy reforms. The new law was meant to shift the advantage from corporate borrowers to lending banks, which could assume ownership of their assets in case of a default, and sell them to recover a reasonable amount.

But the law is of no use if banks have to take an 87% haircut. This shows that corporates have taken out much of the money they borrowed from banks, hollowed out their company and happily handed it over to the courts, under the bankruptcy law. In most instances, it looks like companies were stripped of their assets. Funds have possibly been stashed abroad via the standard procedure of over-invoicing the value of imports. It’s the oldest trick in the book. Strangely, enforcement agencies like ED don’t go after these cases with the same vigour that they show in the case of Opposition leaders or political dissenters.

Also read: India’s Unorganised Sector Is Being Engulfed, Further Marginalised

In many cases, asset-stripping or diversion of bank funds to other entities should have invoked the ‘wilful default’ clause. There is no transparency about how many defaulting companies have been named for wilful default, calling for a deeper probe by enforcement agencies. Former RBI Governor Raghuram Rajan had written to the PMO some years ago, giving a list of defaulting corporates which should be investigated for wilful default and even fraud. Nothing further is known, because the RBI drops a veil of secrecy on the names of corporates which may have wilfully defaulted.

The bankruptcy law also suffered a big setback sometime ago, when the Supreme Court ruled that the National Company Law Tribunals, which conduct bankruptcy proceedings, have the discretion to accept or reject a bank’s plea to take over a defaulting company. In one case, a prominent defaulting company argued before the NCLT that it could not pay back loans because of several legal disputes with the authorities, which hampered business operations. Typically, this argument has been made by infrastructure companies which depend on the government and regulatory authorities for clearances. The order of the Supreme Court giving such discretion to the NCLT has come as a major set back to the creditors ― the banks. It may also be noted that over 70% of loan writeoffs have happened in public sector banks.

After such writeoffs, banks have had to depend on the government to infuse additional capital of several lakh crore. This is just taxpayers subsidising massive loan defaults by corporates, from which recoveries by courts have been abysmally low. This would further embolden corporates, who know that the taxpayer will keep bailing them out.

The new law was supposed to transform the credit culture and create a new framework to hold corporates to account. One doesn’t know if any of this is really happening, after seeing the operation of the bankruptcy code in the last six years.

This article was first published on The India Cable – a premium newsletter from The Wire & Galileo Ideas – and has been republished here. To subscribe to The India Cable, click here.