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Twenty years ago, while at the University of Chicago, Raghuram Rajan worked with the Indian Ministry of Finance on a policy measure to ease the burden on Indian banks weighed down by a mountain of bad debts. This was the concept of Asset Reconstruction Companies, or ARCs, which bought toxic assets from lenders at less than their value and then resold them, thus helping to free up capital for banks and encourage new lending. .
Two decades later, and with just over two dozen of these CRAs in operation now, the former central bank chief who sought to end what he called “expand, pretend” business practices local banks may not have negotiated another blow to the integrity of the loan resolution process in India.
This came in the form of a statement by Indian tax authorities who said two days ago their investigations indicated that four CRAs had engaged in unfair and fraudulent business practices while acquiring loans from banks. Worryingly, if the tax claims are true, these CRAs had purchased bad debt using funds from borrowing companies through fake outfits at a fraction of the actual value of the assets while hiding the profits. This would mean helping to regain control of a business or asset from the original defaulter or promoter – a complete abuse of the resolution process while depriving both lenders and the government of revenue. This should perhaps come as no surprise to anyone who has closely followed the trajectory of the loan resolution process or the credit culture in the country.
Large Indian borrowers have long been adept at playing with the system. The country’s South Asian neighbors and several other countries had promoted resolution companies to address the bad debt challenge in the 1980s and 1990s. But few countries would have cast the sink like successive Indian governments in attempting to resolve the problem. bad debt problem for more than two decades. There was, of course, the 2002 law on the securitization and reconstruction of financial assets and the application of collateral, or SARFESI, to give muscle to lenders, a stabilization fund for assets in crisis bringing together ??9,000 crore to hold bad loans from IDBI, a joint lender forum to decide how to solve the problem, a strategic debt restructuring program to convert debt to equity, and a sustainable debt structuring program. stressed assets, referred to as S4 A. This was all before the formal insolvency process, the Insolvency and Bankruptcy Code, or IBC, started in 2016.
And five years after the start of this new law, initially recognized as a gamechanger and which had changed the conditions of engagement between the borrower and the lender for the benefit of the banker, there is a feeling of déjà vu. The promise of a quick shutdown, either an investor buyout of the asset or liquidate within 270 days, appears to be fading with lengthening court hearings and accusations of handing over assets after a huge haircut to a few influential people or well-connected companies.
The fact that successive decades of bad debts pile up is not only a reflection of the judgment of loan appraisal and monitoring skills of lenders and the integrity of many borrowers, but the inability to enforce loan contracts in a timely manner. And no one gets hit as hard as the government, being the dominant shareholder of many banks when there is huge destruction of value because of it all. And when it hampers the overall efficiency of the financial sector and the economy. The opportunity cost may well be in terms of languishing as an average developing economy.
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