According to a report by CRISIL, resolutions of non-performing assets (NPAs) of banks under India’s Insolvency and Bankruptcy Code (IBC) was the highest in FY 2023-24, with 269 cases receiving approval of the National Company Law Tribunal (NCLT) which were 42 percent higher compared to FY 2022-23 when 189 cases were resolved.
NPA is a fancy nomenclature for a loan that has gone bad. A loan account becomes an NPA when interest and/or installment of principal remain overdue for a period of more than 90 days. Resolution is the process of recovering value from the NPAs. To enable banks to pursue resolution of NPAs on the fast track, in 2016, Modi – government had enacted the IBC superseding multiple subsisting laws. NCLT is a quasi-judicial authority to which an NPA account is referred for resolution if the bank/banks can’t resolve.
The higher case resolution momentum is a result of continuous efforts to improve the resolution throughput rate of IBC through structural reforms, the most prominent being the appointment of 15 additional NCLT members in the latter part of FY 2022-23, according to CRISIL. However, a disconcerting aspect brought out by the agency has to do with ‘how much value the banks recovered?’
During FY 2023-24, recoveries by financial creditors under the resolution plans was 27 percent of admitted claims – down from an already low of 36 percent recorded during FY 2022-23. Put simply, it means that out of Rs 100 claimed by the creditors, NCLT could fetch them only Rs 27. Moreover, the time period over which resolution happened for cases completed in 2023-24 was 850 days compared to 825 days in FY 2022-23. This is against permitted time frame of 180 days (plus 90 days in exceptional circumstances).
The data released by the Insolvency and Bankruptcy Board of India (IBBI) last year presents a bleaker picture. According to the IBBI, of the total 5,636 cases under IBC, 3,637 have been closed. Of the closed cases, nearly half i.e. 1,703 ended in liquidation. Besides, the recovery by financial creditors had plummeted to a record low of 10.2 percent of the admitted claims during January-March 2022. Moreover, in 363 major cases, banks took a hair-cut of 80 percent on an average (for some such as Videocon, it was even higher at 95 percent).
It seems that both the government and banks had got reconciled to a situation of steep haircut. This may also be seen from the broad contours of the action plan put in place on September 16, 2021 for the National Asset Reconstruction Company Ltd (NARCL) which was announced by the Union finance minister, Nirmala Sitharaman in her 2021-22 budget speech to take over and dispose of the stressed assets of commercial banks worth Rs 200,000 crore.
Under the plan, the NARCL would purchase in phase I, NPAs worth Rs Rs 90,000 crore for which the banks had made full provision in their balance sheet and remaining Rs 110,000 crore in phase II. The purchase was to happen under the so called 15:85 structure. It involves the NARCL paying 15 percent of the agreed/discounted value of the loans in cash and issue Security Receipts (SRs) for the rest.
The Union Government will provide sovereign guarantee – valid for a period of 5 years – for the SRs issued by NARCL. The guarantee would be invoked to cover the loss being the difference between the realized value (resolution/liquidation) and face value of SRs. A provision of Rs 30,600 crore had been made for this purpose. This budget provision tells the entire story.
The entire banks’ bad loan book of Rs 200,000 crore would be available to NARCL for a mere 18 percent of the face value or Rs 36,000 crore implying a deep haircut of 82 percent. Even out of Rs 36,000 crore that the NARCL pays to the banks, it shells out a meager Rs 5400 crore from its pocket – being 15 percent upfront payment in cash – and need not bother about the rest Rs 30,600 crore as the same is protected by sovereign guarantee. Effectively, the haircut on these NPAs is Rs 194,600 crore or 97.3 percent.
A predominating reason for the loss of value is an inordinate delay in completing the resolution process. Analysis of resolutions by CRISIL over the past three financial years indicates that a one-year delay in resolution depletes the recovery rate by 8 – 10 percent. When, it takes 850 days (time taken for cases approved in FY 2023-24) to complete the process which is nearly five times what is permissible, a steep decline in the realizable value is inevitable.
What causes delays?
A paramount reason has to do with judicial overreach that has literally rendered IBC process dysfunctional.
As per a circular issued by RBI on February 12, 2018, for accounts with aggregate exposure greater than Rs 2,000 crore, as soon as there was a default in the account with any lender, all lenders – singly or jointly – shall initiate steps to cure the default by preparing and implementing a resolution plan (RP). This needed to be done within 180 days from the date of default. In case of failure to meet this deadline, the lenders were required to refer the account to the NCLT for resolution under the IBC. The NCLT would get 180 days to complete the process.
Following petition by defaulting borrowers, the Supreme Court (SC) declared the February 12, 2018 circular unconstitutional. This forced RBI come up with a revised circular dated June 7, 2019.
The June 7, 2019 gives banks 180 days to come up with RP. If the banks don’t meet this deadline, they have to make an additional provision of 20 percent. If they don’t finalize within a year, an additional 15 percent has to be made taking the total to 35 percent. Add to this, normal ageing provision of 40 percent (applicable in case the loan default extends up to 15 months), the total provisioning will be a steep 75 percent. Having provided for such a huge amount, there won’t be any incentive left for the bank to recover the money under IBC.
This has led to a scenario where the banks are neither under any compulsion nor have any interest in referring the NPA for resolution under IBC. The soul of IBC process lies in inviting bids for the entity as a ‘going concern’. This way alone, it is possible to maximize value thereby trimming the haircut. By striking down the February 12, 2018, RBI circular, the SC has struck at the soul.
Still, the IBC framework has brought about a fundamental change in the behavior of the borrower. By instilling a sense of fear that continuing default could result in his losing control over the firm, it has forced a large number of them to clear all their dues. According to Sitharaman, 28,000 cases involving Rs 1000,000 crore have been disposed of, prior to admission into insolvency proceedings. Needless to say, the erosion of realizable value in those cases was minimal.
Besides, a series of governance reforms implemented by Modi – government in public sector banks (PSBs) have galvanized them to promptly recognize stressed assets and take stringent measures for their recovery which is reflected in reduction in gross NPAs to a record low of 2.8 percent on March 2024