Stirring a corporate hornet’s nest

Just days before he was transferred from his job as India’s finance minister in June, Yashwant Sinha tried to fulfil an old promise to strengthen the rights of creditors.

By pushing through a new ordinance, yet to be cleared by parliament, that will help banks get tough with defaulters, Sinha stirred a hornets’ nest among India’s corporate bigwigs. Jaswant Singh, his successor, faces a tough challenge in trying to get parliament to support the draft law.

Indian companies, long protected from bankruptcy or foreclosure by old socialist laws, are outraged. In the past they simply declared themselves sick to escape paying back loans or to prevent creditors from taking over secured assets. Once placed under the Board for Industrial&Financial Reconstruction, a rehabilitating agency, they could strip assets, leaving creditors high and dry. Under the proposed law, lenders can issue a 60-day notice to a defaulter at the end of which they are free to take charge of secured assets, sell or lease them or even change errant managers. It will also create an asset reconstruction company to buy $16.77 billion-worth of bad loans on the books of banks and financial institutions.

There are several reasons why so many hackles have been raised over the ordinance. Indian companies are still largely financed by bank loans rather than the capital market and are adept at using weak corporate governance in banks to their advantage. The government’s economic survey points out that 60% of their debt is loans from banks and financial institutions, while just 21% of it is in bonds. Figures put out by the Reserve Bank of India, the central bank, say bank credit averaged 4.3% of GDP annually in the past decade while debt and equity issued in the capital market averaged just 1.7%.

Of the Rs15.9 trillion ($331.3 billion) in financial assets owned by banks and financial institutions at the end of March 2001, Rs805 billion was non-performing. Around 85% of the non-performing assets of banks is on the books of 27 state banks. While these figures might not be alarming, analysts say the actual figure will be much higher once Indian banks move to the international norm of defining a non-performing asset as one that has been in default for one quarter (instead of two).

Just how much of these bad loans can be recovered is doubtful, given the poor quality of the collateral. But at the very least banks should be able to free up the provisions they have made on the loans. K Kannan, a former chairman of Bank of Baroda, a large state bank, estimates that Indian banks have provided up to 40% on their bad loans. That should enable banks to raise cheaper capital and grow their loan books again. Bank shares moved up this month; at least five state banks have IPOs lined up.

At a meeting organized by the Indian Banks Association in Mumbai on July 20 to discuss the ordinance, bankers were upbeat. Two big state banks, State Bank of India and Bank of Baroda, are said to be preparing to send notices to defaulters calling in their loans. In new loans BoB is doing away with a secrecy clause that prevented the bank from disclosing the identity of the company in default, says its general manager in charge of recovering bad assets.

R Ravimohan, managing director at Crisil, a credit rating agency and local partner of Standard&Poor’s, points out that having the law on their side will help creditors. “It makes bankers legally accountable and should cut out political interference,” he says. Just threatening to tighten the noose has made companies cough up money in the past, he adds.

Corporates fight back

Meanwhile business lobbies are working hard to dilute a key clause in the proposed law. According to this a company must first deposit 75% of the outstanding loan with the bank before it can appeal against the lenders’ decision before a debt tribunal. That makes it expensive for those companies that use India’s impossibly overburdened courts to stall foreclosure for years.

Leading business lobby groups such as the Confederation of Indian Industry and Federation of Indian Chambers of Commerce&Industry charge that banks will get unfettered rights once the new law comes into effect. One banker says: “Lenders accounting for three fourths of the outstanding loan to a company in default must agree to recall a loan or change managers. That rules out rash, unilateral action by any one lender.”

Foreign banks like the new law but are watching how tough India’s 27 state banks and financial institutions will actually get. Indian banks, unlike foreign ones, loathe writing debts off their books and prefer generous debt workouts. One banker at a US bank scoffs at recent cases where Indian banks converted loans in default into zero-coupon bonds. As junior partners in the loan syndicates (Indian companies borrow mostly in rupees), foreign banks have few options. The proposed law is a good tool but will Indian banks use it, asks the sceptical American banker?

The ordinance must be cleared by parliament within six months (the ongoing session ends in mid-August) failing which the president must grant it an extension of another six months. There is too much at stake on both sides for a smooth passage through parliament.