Bankruptcy Code Isn’t Enough; We Need SUUTI-Like Body To Take On Banks’ Toxic Assets

It is good for India to have an Insolvency and Bankruptcy Code (IBC), but the code is not going to quickly solve the problems it was meant to deal with: recovery of bad loans under a time-bound process. And we have also done a wrong thing by empowering the Reserve Bank of India (RBI) to speed up the bad loan resolution process by forcing banks to push large defaulters towards insolvency proceedings.

The problems relate to three roadblocks.

First, the RBI, which has no experience in running a bank, will end up taking an aggregated approach in deciding which cases should be sent to the bankruptcy courts. Its very first decision, which involves sending 12 big defaulters to the National Company Law Tribunal (NCLT), was taken based on the size of defaults, and probably does not differentiate between loans that could come good at some point, and those which never can. HDFC Bank managing director and chief executive officer Aditya Puri has already gone on record to say that insolvency should not be the first option for defaulters, unless the case is one of wilful default. But if you leave it to the RBI, which is in no position to judge wilful defaults from temporary defaults forced by market conditions, it will use blunt weapons rather than precision ones, which only bankers are equipped to wield.

Second, as the regulator, the RBI also has to ask banks to provide capital against cases sent to the NCLT, and banks have to provide at least 50 per cent for the 12 cases which were identified for liquidation proceedings. The problem is that this will force the government to pony up the capital. Now, if the government is anyway going to pick up the bill, why can’t it take the crucial decisions on which ones should be liquidated itself?

Third, the country does not yet have enough insolvency professionals and lawyers to deal with so many cases in the 180 days prescribed by the bankruptcy code. So, the chances that we will see 12 complex cases resolved this year are small. There is provision for extending the period by 90 days if 180 aren’t enough, but this means some proceedings will close only by the first quarter of 2018-19.

If Prime Minister Narendra Modi wants banks to restart the lending cycle before 2019, he must take another route. He cannot afford to send so many companies into liquidation, never mind which ones can come good at some point, and which ones can’t.

Two options are worth considering. One is the US Troubled Assets Relief Programme (TARP) legislated by Congress in October 2008. Under TARP, Congress committed itself to purchasing $700 billion of troubled assets from the beleaguered financial sector. But barely six years later, it had invested around $426 billion and recovered $446 billion. In short, it ended up with a small surplus when the programme was wound down.

We have our own experience with the Specified Undertaking of the UTI (SUUTI), which was created in 2002 when Unit Trust of India found its liabilities to unit holders exceeding its assets. SUUTI was created to take over the toxic assets, and the mutual fund and trustee company hived off from it. Today, SUUTI is sitting on a goldmine, with large quantities of shares in Axis Bank, L&T and ITC.

In 2015-16, SUUTI’s income exceeded expenditure by Rs 1,143 crore, and assets ran into tens of thousands of crores. The government is making money by selling SUUTI assets on the market.

SUUTI, which is run by an administrator and has developed competence in buying and selling securities and disposing of non-performing assets, could conceivably be reworked as a vehicle for holding banks’ toxic assets, modelled on the lines of the US TARP.

The scheme could run in the following manner.

Let’s say the 12 companies sent for liquidation owe banks Rs 200,000 crore. On this banks are said to have already provided for around 40 per cent, which means the net toxicity in the assets is about Rs 120,000 crore. SUUTI could conceivably buy this asset for Rs 120,000 crore, paid for by bonds of the same value issued by the government. SUUTI’s administrator can theN pursue the liquidation proceedings on its own. Banks which have provided more than 40 per cent will now have surpluses to accelerate bad loan write-offs too.

This way of doing things will resolve banks’ woes faster than sending every big defaulter to the NCLT. It can be done in less than six months, with only a small legislative change needed in the SUUTI Act.

A bonus: since SUUTI already has huge assets, its capital requirement could be smaller than if an entirely new structure has to be created to take over toxic assets.

Other asset reconstruction companies can be asked to bid for the same toxic assets, so the net price paid by government can be even lower than Rs 120,000 crore, which too could conceivably be recovered at a future date.

Another option would be to use an existing 100 per cent government-owned bank to buy out all the toxic assets, and raise funds both through the issue of government bonds and by selling the deposit operations to other banks. In short, convert an existing bank into a bad bank by making it focus only on insolvency cases.

The insolvency law is what the doctor ordered for India, but if Modi wants to get things moving faster to get banks fighting fit again, he has to help them get rid of their toxic loans faster. IBC is not the place to start.

SUUTI, or a TARP-like organisation, may be important supplements to the bankruptcy code. The main gain is that banks will be able to forget their bad loan burdens and start on a new slate again – faster.