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Bankruptcy code: Jaitley should speed up, as Rajan is moving faster than him

If Arun Jaitley does not quickly get a comprehensive corporate bankruptcy code in place, he may have one more bone to pick with Reserve Bank of India Governor Raghuram Rajan. As banking regulator, Rajan has steadily put his own bankruptcy code in place to protect banks, and Jaitley will have to work work around the system set up by the regulator instead of starting on a clean slate.

 Bankruptcy code: Jaitley should speed up, as Rajan is moving faster than him

Union Finance Minister Arun Jaitley. Image courtesy PIB

In his budget speech this February, Jaitley said: “Bankruptcy law reform, that brings about legal certainty and speed, has been identified as a key priority for improving the ease of doing business. SICA (Sick Industrial Companies Act) and BIFR (Bureau for Industrial and Financial Reconstruction) have failed in achieving these objectives. We will bring a comprehensive Bankruptcy Code in fiscal 2015-16, that will meet global standards and provide necessary judicial capacity.”

He’d better rush, for Rajan has been scorching the tracks on bankruptcy and crony capitalism, working from the lenders’ end. Lenders are the principal parties to any bankruptcy code. Yesterday (8 June), the RBI announced guidelines that empower banks to take control of companies which have failed to achieve major milestones under the corporate debt restructuring (CDR) programme. While bank takeovers are easier said than done, the main merit in the move is that Rajan is moving faster in the right direction.

CDRs are loans rescheduled by banks in order to give borrowers a sweeter deal and longer time to repay. Banks also have an interest in CDRs since rescheduling at least postpones the day of reckoning for them. As at the end of March 2015, banks had restructured loans of around Rs 4.3 lakh crore (6.2 percent of total loans), and a big chunk of even this CDR total may go phut this year.

Under RBI’s new scheme of Strategic Debt Restructuring (SDR), banks can band together under the banner of a Joint Lenders’ Forum and convert their existing loans to equity and take over the management.

Last year, the RBI tightened the noose around crony capitalists by allowing banks to categories entire groups as wilful defaulters in cases where even one group firm has failed to pay up its dues to banks.

Even before that, a regulatory change initiated by Rajan’s predecessor, Duvvuri Subbarao (which has now kicked in from 1 April 2015), forces banks to provide 15 percent of any CDR in their P&L accounts. This measure will force banks to take a hit on profits and some could report higher losses from the quarter ending June 2015.

Taken together, the provision for declaring more recalcitrant borrowers as wilful defaulters, the higher provisioning ordered for restructured assets, and enabling banks to take over companies unable to meet their CDR commitments will shift power away from borrowers to lenders.

Of course, it is always possible for defaulters to move the courts and delay action – as Vijay Mallya did with Kingfisher Airlines when United Bank declared him a wilful defaulter – but this is where the new Strategic Debt Restructuring (SDR) move may make a difference.

A key element in the SDR guideline says that banks will have to incorporate new clauses in their CDR mandates under which promoters will have to get shareholders to agree to special resolutions authorising the conversion of bank loans to equity if the loan conditions are not met. The RBI says no restructuring will be permitted without such authorisations by a special resolution.

Once banks are armed with shareholder and other authorisation to convert loans to equity, even the courts may not be able to delay things for too long. But then, Mallya used the courts to stymie banks. The courts could play spoilers.

Banks also have an additional incentive for opting for SDRs: when they take control, they get another 18 months to avoid taking a hit on their books. The RBI guidelines say the following: "On completion of conversion of debt to equity as approved under SDR, the existing asset classification of the account, as on the reference date…..will continue for a period of 18 months from the reference date."

The upshot of the RBI’s actions is that the regulatory action towards a bankruptcy code is moving faster than the legislative process.

Jaitley needs to get a move on. A comprehensive bankruptcy code legislated by parliament will ensure that the courts cannot be used to delay action on bad loans. It will be a powerful blow against crony capitalism, enabling banks to recover bad loans and put terminally ill companies out of their misery.

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Updated Date: Jun 09, 2015 19:02:06 IST