Insolvency / Bankruptcy code
Preface :
- While there is greater awareness about GST / Demonetization and there is enough debate about itpros and cons, one of the most important legislation and equally important legislation which is passed by the Govt is the Insolvency and Bankruptcy law (IBC) .
- What's the significance of this law with respect to our banking industry ?
- Is Vijay mallya’s 8000 Cr or Nirav Modi’s 13000 Cr PNB scam , the only problem with the public sector banks? How is IBC related to Vijay mallya ?
Introduction :
Before getting into the IBC / NCLT ( Sort of special court for solving Insolvency cases ) , it’s very important to understand the overall banking system in India. I will provide you with some important stats and how RBI works and how money circulation works in the country.
- As you all know bank is an intermediary between the depositor and lender. When you deposit 100 Rs with the bank , banks lend this money to a lender for an interest say 10 % and has a deposit rate of 5 % as a result the bank makes money for itself (Owners / Shareholders) and for the depositor as well.
- Now what if the lender does not repay the money. The bank is obliged to pay back the depositor . Hence in order to provide various safeguard mechanism to the depositor RBI has devised basic set of guidelines / rules for banks.
- It is not that whole 100 Rs you deposit with the bank can be lend. The below mentioned are some of the important terms / important restrictions RBI imposes on banks to safeguard depositors money.
RBI banking terms :
- RBI does a policy meeting every quarter where one of the mandate of the RBI is to regulate the Indian banking sector . In addition to this RBI has mandate on Inflation management , Foreign Exchange Reserve etc.. RBI uses the following tools to restrict / release money supply into the banking system
- They are CRR , Repo Rate , Reverse Repo rate , SLR. In addition there are other rates such as MCLR , Bank rate etc. Note that these rates are dynamic and during every policy meet RBI adjusts these rates.
- CRR - Cash reserve ratio is certain percentage of the banks total deposits that has to be kept in the current account with RBI which means banks do not have access to that much amount for any economic activity (Lending) or commercial activity. During every policy meeting RBI decides whether to increase or decrease the rate.
- As of today the CRR of 4 % . which means that for every 100 Rs you deposit in bank 4 Rs will be deposited by bank to RBI. This money cannot be used for any other purpose and banks dont earn any interest on this money.
- Repo Rate : The repo rate is the rate at which the central bank lends short-term money to the banks against securities.In case banks have more demand for lending then banks can borrow from RBI at the rate prescribed by RBI. The current Repo Rate is 6 %
- Reverse Repo Rate : In contrast, the reverse repo rate is the rate at which banks can park surplus funds with the reserve bank. In case banks have excess deposit with them and they are not finding enough demand to lend then they can park the money with RBI and earn interest. The current reverse repo rate is 5.75%
- SLR - Statutory liquidity ratio (SLR) is the reserve requirement that the commercial banks are required to maintain in the form of cash, gold reserves, government approved securities before providing credit to the customers. The current SLR ratio is 19.5 % . Which means that of the 100 Rs you deposit with the bank 19 .5 Rs should be deposited in either gold reserve , govt bonds etc.
- In general even though you deposit 100 Rs with bank , 19 rupees goes in SLR , 4 Rs goes to CRR and banks are left with only remaining 77 rupees to lend.
- During each RBI policy meet , RBI adjust these rates based on the money circulation in the country. Remember more the money circulation in the country , higher will be the inflation . Less money will lead to less demand and there will be no growth . Hence liquidity / inflation management is one of the most complex work undertaken by the RBI.
To get the updated policy rates please visit this link : https://www.rbi.org.in/home.aspx See the CURRENT RATE tab to look for the latest rate.
- CAR - Capital Adequacy Ratio : In addition to above ratios which are used to protect the interest of the depositors , another important ratio is the CAR - Capital Adequacy ratio.
- Capital requirement (also known as regulatory capital or capital adequacy) is the amount of capital a bank or other financial institution has to hold as required by its financial regulator. This is usually expressed as a capital adequacy ratio of equity that must be held as a percentage of risk-weighted assets. As of now all Indian banks are needed to follow Basel 3 regulation norms. The Basel 3 norms has 2 sub divisions which are Tier 1 capital and Tier 2 Capital. For more details on this please visit this link to understand.
Too complicated to understand ? Follow this below example carefully. Please remember these terms are important.
- Assume that you start a bank with an initial investment of 100 Cr , then the max amount of money you can lend is approx only 1000 Cr. ie 10 times your own capital . This is a regulatory requirement by RBI where max you can lend is only “n” times your own capital ( which is equal to Tier 1 + tier 2 ) . The “n” varies according to RBI guidelines.
- When the bank has 2000 Cr depositors money and 100 Cr of own money ( Shareholders money) the bank has to set aside ( 5 % CRR + 19.5 % SLR = 25 % ) 500 Cr of 2000 Cr for regulatory requirement. Hence it has 1500 Cr remaining to lend . However since its capital is only 100 Cr it can lend only 1000 Cr even though it has 1500 Cr of depositors money.
- Now in the 1st year assume that the bank lends this 1000 Cr at 10 % interest and makes 100 Cr as profit, in the second year the banks own capital also known as equity capital is 100 Cr initial investment + 100 Cr profit recorded in 1st year =200 Cr . Hence during 2nd year the bank has potential to lend upto 2000 Cr.
- During the second year the bank lends 2000 Cr to 20 different customer 100 Cr each and it has the potential to earn 200 Cr as profit ( 10 % interest on 2000 Cr loan). However, 1 of the customer with 100 Cr loan defaulted. As a result the bank loses 10 Cr of potential profit. As a part of RBI regulatory requirement 75 % of the NPA amount should be kept aside as provision.In our scenario the bank marks this 100 Cr as NPA and from the 200 Cr of its own capital (Shareholders money) it has to set aside 75 Cr ( 75 % off 100 Cr NPA ) as provision which cannot be used for other purposes. Now the bank declares 5 % as its
Gross NPA ( (100 Cr NPA loan / 2000 Total Loan ) * 100 ) and as it set asides 75 Cr as provision its Net NPA will be ( 100 - 75 = 25 Cr ). 25 /2000 * 100 = 1.25 % expressed in % terms.
- Why is this needed ? Here again in order to protect the depositors, the bank and shareholders of the bank needs to take a hit first rather than the depositor. Hence the bank has to be very careful while lending because incase they are not able to recover the money , it's the shareholders of the bank who takes the hit first rather than the depositor.
Please understand the above example clearly because this is the basis of our banking. There are other complications to this rule such as Gross / Net NPA etc but for our understanding we will leave it here. Now let's come to the whole banking system of our country.
Indian Banking System - An Overview :
- The Indian banking system consists of 27 public sector banks, 26 private sector banks, 46 foreign banks, 56 regional rural banks, 1,574 urban cooperative banks and 93,913 rural cooperative banks, in addition to cooperative credit institutions. Public-sector banks control more than 70 per cent of the banking system assets, thereby leaving a comparatively smaller share for its private peers.
- As a result of demonetization most of you now know that the total money circulation in our banking system is approx : 18 Lakh crore ( 17.78 Lakhs Crore Exactly )
- The total amount of deposit with the Indian banking system is approx 110 Lakhs crore and the total amount of all the loans given stands at a staggering 83 lakhs crore as of Dec 2017.
Table 1 :
Category ( In crores)
|
Deposits
|
Advances / Credit
|
SBI
|
25564337
|
16327485
|
National Public Sector
|
50136308
|
36332342
|
Regional Rural banks
|
3754424
|
2404708
|
Public sector total
|
79455069
|
55064535
|
Private Sector
|
26407855
|
24136810
|
Total
|
110552854.4
|
83015981
|
Public Sector Market Share
|
71.9%
|
66.3%
|
Private Sector Market Share
|
23.9%
|
29.1%
|
Note : Foreign bank details are not added here. Hence % might not add to 100
- How is it that only 17 lakh crore of printed currency corresponds to 110 lakhs crore deposit and nearly 5 times 17 * 5 = 80 lakh crore of lending. That is every 1 rupee deposited with bank has the potential to lend itself to 5 rupees.
- Its because the amount you deposit with the bank is lent to a person named “X” and he pays an interest to the bank which in turn is lent to another person “Y” and the cycle goes on. That’s how every 1 rupee deposited with bank has the multiplier effect of approx 5 times.
- While it is still debatable whether demonetisation is a success or failure , various estimates suggest that 3 lakh crore is black money which has come into the banking system now . Or in other words, a potential of about 15 lakh crore of loan which can be given to needy people were blocked as black money before demonetization.
- Of this Approx 83 Lakh crore advances ( loan ) or approx 70 % market share is held by public sector bank and remaining 30 % market share is held by private sector as shown in the above table
- Out of this 83 Lakhs crore lending , the total outstanding gross NPA of the public sector bank is approx . 7.34 lakh crore and for the private sector it is approx. 1.03 lakh crore. Ie 10 % of the whole Indian banking system money is NPA.
- While 8000 Cr of loan given to Vijay Mallya is not a small number and there is no argument to this fact, compared to the size of the Indian banking sector NPA problem Vijay Mallya's 8000 Cr loan is just 1 % of the problem.
Sector which contributed to the NPA problem :
- Steel and Power Sector were the primary contributors to the NPA problem in the banking sector. During the period between 2008 to 2015 large number of Ultra mega power projects were started and companies like Bhushan steel , Essar steel started creating mega steel plants.
- Suppose say you need to start a steel project which costs 100 rs , 30 % of the money should be your own money (Equity) or investor’s money and the remaining 70 % of the money can be taken as a loan.
- However what happens in most cases is that the cost of the project will be estimated at 120 Rs ( even though the actual cost will be 100 rs ) and 70 % of the money ie 84 rupees will be taken as loan and only 16 rupees will be from the promoters who own the money.
- This happens because of bad underwriting standards / bad estimates of the risk in our banking system and not so good corporate governance practices from the companies as well. This doesn't mean all the steel companies / projects are funded in an unethical manner. Each and every steel / power sector project scenario differs.Please find below the list of top companies and their loan data . These 12 companies contributed to 25 % of the NPA in the banking sector.
Table 2 :
Company Name
|
Loan Amount
( In crore)
|
Bhushan Steel
|
44478
|
Lanco Infratech
|
44364
|
Essar Steel
|
37284
|
Bhushan Power & Steel Ltd
|
37,248
|
Alok Industries
|
22,075
|
Amtek Auto Ltd
|
14,074
|
Monnet Ispat and Energy Ltd
|
12,115
|
Electrosteel Steels Ltd
|
10,273
|
Era Infra Engineering Ltd
|
10065
|
Jaypee Infratech Ltd
|
9635
|
ABG Shipyard Ltd
|
6,953
|
Jyoti Structures Ltd
|
5,165
|
Reason for huge NPA in Steel / Power Sector :
- Remember there is no one particular reason for the NPA problem in the banking sector. The following were some of the major contributors for the NPA problem in the steel / power sector
- Coal is one of the most important raw material for both coal based power projects and steel sector as well.
- During the UPA period and period earlier the Supreme Court observed that nearly 218 coal blocks were arbitrarily allocated and this amounted to unfair distribution of national wealth. Hence the Supreme court cancelled all the license awarded to the companies.
- Once the coal blocks were de allocated the power / steel companies which were dependent on these coal blocks were not able to produce any steel or power and incase there is no production there won't be any money to make profit and repay the loan taken. Hence the banks were affected the most.
- In addition, chinese companies were dumping the steel produced in their country at a cheaper rate here. This made the cost of steel production in India unviable and our local steel producers such as JSW , Tata Steel etc suffered.
- Some of the companies such as Essar are not good with respect to their corporate governance practices / Ethics.
What the RBI / Govt did to solve these problems ?
- RBI during the period 2011 to 2015 when Dr. Raghuram Rajan was the governor of RBI came up with multiple measures to solve the NPA problem using schemes such as S4A , 5 / 25 etc. In Case you need more details on these schemes please refer to the source link. Post the IBC law these schemes are scrapped by RBI now .
- S4A - Scheme for Sustainable Structuring of Stressed Assets (S4A) S4A envisages the determination of a sustainable debt level for stressed borrowers, and bifurcation of outstanding debt into sustainable debt and equity/quasi-equity instruments, which are expected to provide upside to lenders when the borrower turns around.
- 5 / 25 - The 5:25 scheme allows banks to extend long-term loans of 20-25 years to match the cash flow of projects, while refinancing them every 5 or 7 years. Until now, banks were typically not lending beyond 10-12 years.
Source :
- On the other end the government started auction of the coal mines in a transparent manner rather than arbitrary allocation. One who bids the highest amount gets the mines ( There will be other criteria s as well. But usually the highest bidder will be awarded the coal mine )
- Government increased the import duty on steel for import from Chinese which helped domestic steel companies and helped in the revival of the sector.
- Banks were initially very reluctant to address theNPA problems and instead of recognizing the problem and making adequate provisions these banks were postponing the problem. Remember once an account is recognized as NPA, banks have to make adequate provision from their own money ( read shareholders money) rather than depositors money.
- Bankers due to fear from agencies like CAG / ED didn’t take the decision to recognize these steel / power NPA’s initially . However due to pressure from RBI and Govt banks started acting.
- Since RBI forced the banks to recognize the NPA, banks in turn forced the promoters of the companies to bring in more money.
- The promoters for various reasons did not bring in more money to the table and even though the banks had the assets of the steel / power plants as a collateral the banks were not able to get hold of these assets or force the promoters to bring more of their own money due to the weak legal system in our country.
- In all these high ticket loan items, in order to reduce the risk multiple banks form a consortium and then lend money to these steel/power companies. There will be a lead banker who will be the majority lender. Assume that 10 banks such as SBI , PNB . ICICI lend to Essar steel for a steel plant with SBI as the lead banker and when Essar is not able to pay the loan , SBI and PNB might recognize the loan as NPA however ICICI won’t recognize the loan as NPA. This created more confusion / complexity in the system .
- In spite of all these measures from Govt , RBI and banks the problem didn't get fully resolved.
Insolvency and Bankruptcy Code :
- With limited success and understanding that the issues are not getting resolved in spite of the above measures taken by RBI / Govt and banks the Govt passed the Insolvency and bankruptcy code in August 2016 . Even though the law was tabled in the parliament in 2015 the IBC law was referred to a Joint Committee of Parliament on 23 December 2015 finally the IBC law was passed by the Lok Sabha on 5 May 2016 and by the Rajya Sabha on 11 May 2016.
- Before this IBC law , due to lack of strong legal system in the country the banks were forced to take a haircut in their lending and the promoter were not ready to bring money and were gaming the system. However post the IBC law , the banks have an upper hand and can force the promoter to pay back or sell the company or liquidate the asset of the company to get the money the bank has lent.
How IBC works ?
- In case a company or its promoters is not able to pay back the loan to the bank or to the suppliers ( called as operational creditors ) the bank or operational creditors can plea for insolvency by submitting the required details to the NCLT ( National Company Law Tribunal ). The max time allowed to either accept or reject the plea by NCLT is 14 days.
- If the plea is accepted, the tribunal has to appoint an Insolvency Resolution Professional (IRP) to draft a resolution plan within 180 days (extendable by 90 days). During this said period the current promoters/owners of the company and the board of directors of the company stands suspended, and the promoters do not have a say in the operations of the company. The IRP, if required, can seek the support of the company’s management for day-to-day operations.
- The resolution professional appointed can devise a plan to turnaround the company or he can invite bids from other companies and usually the highest bidder is allowed to take over the company. In IBC law existing promoters of the company are not allowed to bid for their own company. In case they pay back all the dues to the banks / lenders only then they are allowed to bid for their own company.
- Hence the banks who has lent will be able to recover the money if not fully but to the max extent possible. All this should happen in time bound manner of 180 days extendable upto max of 270 days.
- In case the resolution professional is not able to find a suitable bidder or turnaround the company within 270 days then the company is liquidated and the assets of the company are sold to recover the money.
- Hence IBC is one of the most powerful law introduced by the Govt to help banks / operational creditors recover money from the companies/ promoters to which it has lent.
- Once the IBC law was passed RBI sent the top 12 NPA companies as listed in Table 2 to NCLT for resolution.
- To give an example of how powerful the IBC is , Essar Steel was one of the 12 companies sent by RBI / Banks to NCLT. The promoters of the Essar Steel company knowing that they may lose the company filed a plea to court stating that the company was arbitrarily sent for IBC process and that the company has the potential to repay the bank. However this argument was not approved by NCLT and now the company is undergoing insolvency . As of today there are 2 companies namely Arcelormittal and Numetal bidding for Essar Steel.
- Take the case of Bhushan Steel, there were a total of 53 lenders to this company with SBI being the lead banker. This company owes bank 55000 Cr approx including interest. Now this company is also sent to IBC/ NCLT and there were 3 bidders namely Tata Steel , JSW steel and Bhushan steel employee association.
- JSW offered a cash payment of 28000 Cr with no equity option to the lenders.
- Bhushan Steel employees offered Rs 50 crore cash upfront and another Rs 28,600 crore over 13 years, while offering 98% equity to the lenders.
- Tata Steel emerged as the highest bidder with 35200 crore upfront cash payment to the lenders along with 12 % equity stake in the company. As and when Tata Steel revives and turns around Bhushan steel, the share price should hopefully raise and lenders can make good profit from the 12 % stake they hold in the company. As of 24 - 03 - 2018 the Resolution professional / Bankers have decided to sell the assets of Bhushan Steel to Tata Steel. Tata steel is awaiting regulatory approval from NCLT , Competition commission to formally acquire Bhushan Steel.
Source :
Conclusion :
- While there is no denying the fact that 8000 Cr Vijay Mallya’s NPA is a pressing issue , there is a bigger issue of more than 8 Lakh Crore NPA which the current govt is trying to resolve through the IBC process of which the top 12 companies comprising 2.5 lakhs crore of NPA is getting addressed on priority.
- In addition the RBI has prepared the next set of 25 companies to be sent to IBC / NCLT for resolution process.
- The IBC law is very new for our country and hence based on the current progress the govt is making many changes to this law as of today and hopefully someday in future most of these NPA issues gets resolved.
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