To pursue wilful defaulters

The government finally moves to enable banks and financial institutions to go after defaulting borrowers effectively. But some aspects of the legislative measure, its timing and its sequencing in relation to the ongoing financial liberalisation programme create apprehensions.

THE Union government has finally bestirred itself to crack down on wilful defaulters to banks and financial institutions. On June 21, it promulgated the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Ordinance, 2002. On July 20, Finance Minister Jaswant Singh introduced a Bill in the Lok Sabha to replace the ordinance. The legislation with far-reaching implications is likely to enable financial entities to recover their non-performing assets (NPA), which run into thousands of crores of rupees. Publicly owned financial institutions stand to gain the most.

Reactions to the ordinance were mixed. Bankers, understandably, welcomed it as they have been weighed down by the problem of NPAs during the last decade. However, the timing of the move and its sequencing in relation to the financial liberalisation programme has raised suspicions that the move is a prelude to the privatisation of the public sector banks (PSBs). It is widely seen as a move that locks the stables after the horses have well and truly bolted.

Bank employees welcomed it, but with some reservations. Naturally, the premier industry associations too reacted with trepidation; the assets of many of their members are among those that would now be under threat of foreclosure.

The sheer quantum of the NPAs, a mild euphemism for outstanding loans owed to banks by persistent defaulters, is mind-boggling. According to the All Indian Bank Employees Association (AIBEA), the premier union which represents bank workers in the country, the NPAs of borrower accounts owing more than Rs.1 crore each to banks and financial institutions added to over Rs. 80,000 crores. Nearly 80 per cent of this is owed to public sector banks and financial institutions. This accounts only for the loans extended and not the interest due. Including interest, the amount will add up to more than Rs. 150,000 crores. The AIBEA recently released a compendium on NPAs, listing each such account involving more than Rs. 1 crore. Although the Reserve Bank of India (RBI) has been publishing detailed figures on NPAs for banks and putting them out on its website as well in the last few years, there was no indication that large-scale borrowers felt any pressure, moral or otherwise, until the government moved the ordinance.

The ordinance will enable banks to exercise their right to take possession, sell or lease the secured assets. Lenders can give a notice of 60 days to borrowers who have defaulted for more than six months. They can take over the management of the business units of the defaulting borrowers. They can appoint a manager to run the unit taken over and recover money that may be due from other parties to the borrowers. In the case of consortia, if 75 per cent of the lenders (in terms of the value of loans extended) initiate recovery proceedings against a borrower, the move shall also bind other lenders. The ordinance prescribes that borrowers who contest the recovery action of lenders must first deposit 75 per cent of the contested amount before the Debt Recovery Tribunal before filing an appeal. Transactions of less than Rs. 1 lakh and cases in which borrowers have paid 80 per cent of their dues are outside the purview of the ordinance.

V.P. Shetty, Chairman and Managing Director, United Commercial (UCO) Bank, told Frontline that the ordinance had brought in measures that bankers had been demanding for long. He said that the measures would help banks improve their balance sheets through "quick realisation of debts, especially where sufficient securities are available". He believes that apart from imposing a "psychological threat" on wilful defaulters, the legislation will enable bankers "to come down heavily" on them. "Banks," he said, "will be better armed to make effective recoveries of their debts", without long-drawn legal battles.

The unions have welcomed the ordinance for making it easier for banks to recover their dues from wilful defaulters. Speaking to Frontline, Santi Bardhan, general secretary, Bank Employees Federation of India, said that that the measures would have real effect only if "drastic and stringent action is taken against defaulters". He suggests drastic measures: confiscation of the properties of wilful defaulters, imprisonment, and blacklisting for all future advances and loans. He said: "Although there may be some cases where for genuine reasons advances have become NPAs, in most cases borrowers turn defaulters wilfully."

S.L. Shetty, Director, EPW Research Foundation, believes that the "bank-industry-politician nexus" is likely to allow only "incremental" steps in the reform of the banking system. "Substantive correction," he said, "is taking a long time, essentially because every logical step that is taken is being subverted by the bureaucracy-political nexus." "I do not feel", he said, "that the fresh law proposed is faulty. Rather, it will be implemented in a faulty manner." He said that banks were under pressure to initiate proceedings against debtors because they were required to make provision in their balance sheets for loans that turned into NPAs. He said: "Although there is no doubt that the law has been introduced because the multinational agencies have been putting pressure on the foreclosure issue, that it is a step in the direction of expanding the scope for foreign and private banks cannot be disputed."

Although S.L. Shetty termed the legislative measures as being "progressive", he said the "government's motivation is not to strengthen the PSBs." He said: "I shall therefore vote for the law, despite the many misgivings I have regarding the motivations and the possibility of corrupt practices that may emerge from its implementation." Although Shetty believes that these measures will have beneficial effects on PSBs, particularly in cleaning up their balance sheets, he points out that the "problem of NPAs in banks is not merely an internal problem of banks, their efficiency and what have you." Shetty argues that the NPA levels have risen because of "faulty" economic policies. The suspension of the planning process, the curtailment of public expenditures, and drastic reductions in investment demand are hurting the growth of the manufacturing sector and breeding NPAs. He said that the government has shown "no awareness of this structural malady afflicting the economy." Shetty regards the measures as being "in line with the government's medium-term goal of privatising the public sector banks." "That," he said, "would be a disaster for the Indian economy." This, he argues, has been "dictated by the international multilateral agencies." "Although the measure (the ordinance) is justifiable to protect the health of the public sector banks, the government's motivation is suspect." "My reaction to the Bill," he says, "is clouded by this fear."

ALTHOUGH bankers have generally welcomed the ordinance, the initial euphoria has been dampened by the realisation that it enables lenders to proceed against defaulters only if they hold collateral security. It is estimated that only 35 to 40 per cent of the NPAs in the banking system are backed thus. Although the move to exert pressure on borrowers has been widely welcomed, the provisions relating to the manner in which recoveries are to be made have attracted controversy. The more contentious aspect of the legislation relates to the formation of asset reconstruction companies (ARCs), which are to act as intermediaries in the market for the pledged securities. The ordinance lays the legal basis for the formation of ARCs. ARCs are to acquire the secured assets of banks and financial institutions at a discounted value. They will enjoy overwhelming authority over such assets. Bardhan feels that the mere formation of ARCs is not a solution to the NPA problem. He fears that it will only serve to clean up the balance sheets of banks. "Moreover," he said, "the exercise will be expensive because in most cases the ARCs will be owned by the private sector, and the private sector works only for profit."

Bardhan pointed out that the Narasimham Committee on financial sector reforms recommended the creation of an asset reconstruction fund, not companies. "Perhaps," he said, "the idea was to create a fund through contributions from PSBs, and from that fund, the NPAs, at their discounted values, were to be used for issuing bonds." Instead, he views the formation of ARCs as being "a dangerous step". "The ARCs will be run by private companies. They will work for profits and they will add to costs," he said. Banks will lose out because the NPAs will be discounted, and they will get only a portion of the funds that are due.

It is feared that such discounting will create a fertile ground for corruption because it will be largely determined by a process of bargaining involving the banks and the ARCs. Tarakeswar Chakraborti, general secretary, AIBEA, told Frontline that the discounting of NPAs "will set in motion a chain of corruption". A large number of the defaulters who created NPAs in the first place will get their property back at a much lower price, and will not have to repay loans. If this becomes a part of the system, those who take loans from banks in future will not be serious about following norms and regulations. A vicious circle that will eat into the vitals of the banking system will be created. He suggests the establishment of an independent statutory audit system in banks, along the lines of the Comptroller and Auditor General (CAG).

S.L. Shetty believes that the discounting of NPAs will result in PSBs being "short-changed" by the ARCs. Significantly, private banks are already ahead in the race to form ARCs. Shetty attributes the alacrity with which private banks take up this business to the fact that they are tuned more to treasury operations than traditional banking operations. Shetty said: "After an NPA is securitised and sold to the ARCs at a discounted price, the lending bank will get nothing extra." After having sold its old loans at reduced prices and thereby booked a loss, the only advantage for the bank is that it will get something instead of nothing. They will not need to make provision for losses for these bad loans that have gone out of their books. The clean-up is thus unlikely to be as painless as the advocates of private banks have made it out to be. Critics of the government allege that the move to clean up the balance sheets of PSBs is aimed at making them attractive for their eventual takeover by private and foreign banks.

Shetty regards the formation of ARCs as a means to bring the concept of junk bonds trading to India. There is outrage that the privately owned ARCs' acquisition of assets at deeply discounted prices would enable them to take over resources that are essentially due to publicly owned institutions.

Indeed, banking industry sources have pointed out that the PSBs cannot avail themselves of the services of the pilot ARC floated by ICICI, since the current legal framework does not allow transfer of their assets to another entity. ICICI has recently set up an ARC with a capital of Rs.5 crores. Created under the Companies Act, it is the first of its kind in the country. The Finance Ministry has defended the dominant role of private sector banks in the ARCs by claiming that their expertise and focus of loan recoveries make them better placed to undertake the task of recovery of loans. Private institutions have clearly enjoyed a lead in the financial mechanisms that have been put in place recently. While ICICI was asked to pilot the ARC, the Housing Development and Finance Corporation (HDFC) has been entrusted with the task of coordinating with the Credit Information Bureau and the Infrastructure Development Finance Company the task of administering the Infrastructure Equity Fund mooted in Budget 2002-03. HDFC plans to bring in foreign expertise to channel and disseminate the database proposed to be generated once the Credit Information Bureau becomes active.

The manner in which the legislation has been moved has raised eyebrows. Although the draft Bill was approved by the Cabinet before the end of the Budget session of Parliament, it was not moved during the session. Critics allege that by doing this, and by promulgating an ordinance in June, the government avoided a thorough examination of the move by the standing committee of the Ministry. This, according to them, explains the rather abnormal situation in which the Bill has been moved barely a month after the promulgation of the ordinance.

Looking back, the sequencing of financial sector reforms indicates that the move is aimed at cleaning up the balance sheets of the PSBs. Logically, the next step would be the dilution of the government's stake in these institutions, or their outright sale to private and foreign banks in a "strategic partnership". Seen from this perspective, the measure fits with the proposed legislation to lower the government's stake in PSBs to 33 per cent. That, in turn, would be in tune with its game plan to withdraw the state from the banking business, leaving the field free for free-wheeling private and foreign financial entities.

With inputs from Suhrid Sankar Chattopadhyay in Kolkata.