Why insolvency code and not stressed-assets funds can help banks fix bad loan woes

The Reserve Bank of India (RBI) governor, Raghuram Rajan’s disagreement in government banks taking majority stakes in the proposed stressed-assets funds is justified. Rajan is right because if a bank controls the stressed-asset fund, it would amount to receivables from the sale being transferred from the bank to the fund. What is more important to note is the fund would be hamstrung in quick decision making, key to its success, with historical baggage coming in the way. Its reluctance to take a haircut, key to the success of ARC or stressed assets fund, would be more pronounced vis-à-vis the one who has had nothing to do with processing or nursing the loan in the first place. Insider knowledge can be both titillating and haunting. [caption id=“attachment_2678064” align=“alignleft” width=“380”]  AFP[/caption] India has had so far as many as 12 ARCs in operation, with none of them registering even a modicum of success in arresting the problem of NPA. The reason is simple and not far to seek. ARCs want the banks to take as large a haircut as possible and the banks want to make the minimum sacrifice possible. They are unable to find a goldilocks solution that would satisfy both. If this is the experience thus far what makes the government more optimistic about stressed-assets funds? Rose is rose by whatever name called. Stressed assets funds are expected to either buy out the distressed loans at a discount and make profit by making recovery from the obstinate borrower more fully if not completely or invest in the equity of the banks to provide them with more financial muscles. The latter is more fraught because while in the first option the difficult borrower alone would be the focus, in the latter focus would be lost with investments melting into the banker’s hotchpotch. Be that as it may. Apart from these conceptual objections, there is a direct and practical opposition to the very idea of ARC or stressed funds. When a loan is bought off at a concession, which is what haircut taken by the bank amounts to, it sends out a wrong signal to the defaulter. The extent of haircut taken by the bank cannot remain a secret for long in this world of peeping toms and analysts. He would laugh up his sleeves especially if his defaults have been wilful. He would be encouraged to look for similar reprieves in the future, and this will have a contagion effect on the entire banking system to its detriment. Furthermore the stressed assets funds regime would be working unwittingly at cross purposes with the nation’s freshly crafted insolvency code. The government should not be a party to the undermining, even if unwitting, of its own solemn law—insolvency code. Under the code the National Company Law Tribunal (NCLT) would adjudicate corporate defaults quickly with the help of insolvency professionals supervised by a professional body. The entire machinery under the insolvency code is vested with powers to launch proceedings against defaulters which ARCs and stressed funds cannot. The insolvency code regime can put the fear of God into the defaulters. ARCs and stressed funds would be interested only in recovering their investments plus making profits. Furthermore, the insolvency code is comprehensive and addresses the concerns of all the stakeholders whereas the ARC and stressed funds regimes are one-dimensional. Lastly, the insolvency code regime can result in misappropriation proceedings being launched against promoters, with disgorgement order doing poetic justice. This cannot happen under other regimes. The government would do well not to undermine the insolvency code even unwittingly. Therefore Raghuram Rajan should go a step further and advise the government against compounding its mistake in institutionalising ARCs with their clone—-stressed assets funds.