Mains Paper 3: Economy | Growth
From UPSC perspective, the following things are important:
Prelims level: Not much
Mains level: Positive handling of bad loans through IBC and other initiative.
India’s bad loan policy is finally moving in the right direction.
Reasons for high default
- Not creating the fear of immediate, automatic and borrower-blind consequences for default is one reason why India’s credit to GDP ratio is a low 50 per cent (Arunachal is 1 per cent, Bihar is 17 per cent, 100 per cent is the average for rich countries).
Reforms in the right direction
- But over the last three years, the new Insolvency and Bankruptcy Code (IBC) and the RBI’s Revised Framework for Resolution of Stressed Assets (RFRSA, issued on February 12 last year) have begun to show impressive results in recognition (we know the truth), deterrence (defaults are reducing), resolution (defaults are being cured) and speed (defaults are being cured faster).
- This is great news for financial inclusion of the small, honest, and non-politically connected.
No difference with willful defaulter Tag
- The “willful defaulter” tag is a distinction without a difference; banks face pain irrespective of whether a default is caused by Fraud , Competition , or Unsustainable Ambition.
- Current court petitions by defaulting sugar, shipping and power companies against the IBC and RFRSA should be dismissed because they want pre-IBC bank behaviour (discretionary bad loan recognition via restructuring or evergreening) that created our pre-IBC regime (Eagle’s Hotel California, where you check in but never check out).
The effectiveness of new reforms
- India’s new policy regime for defaults — IBC plus RFRSA — ensures a time-bound exploration of all business, capital and ownership restructuring options before liquidation.
- It is working; bad loans went from 2.4 per cent in 2007 to 11.6 per cent in 2018 but may now be down to 10.2 per cent.
- And the direct impact of RFRSA lies in annualised reduction in bad loans for recent quarters being the highest in recent years with a huge acceleration in two-way mobility between standard and non-standard loan classifications.
- Of the 82 accounts resolved by the IBC, the average realisation by financial creditors was 48 per cent and average time taken for resolution was 310 days (versus World Bank estimates of 27 per cent and 1,580 days).
- RFRSA fixed birth defects of past RBI interventions like SDR, S4A, JLF, CAP, etc by requiring weekly reporting by banks on all accounts in default anytime during the week with exposure greater than Rs 50 million, requiring all lenders to initiate steps to cure a default with any lender, requiring an independent credit opinion for resolution plans, and setting a 180-day implementation deadline for resolution plans in loans greater than Rs 2,000 crore.
- Litigation has choked the pipeline with resolution for only three of the RBI’s first IBC list of 12, only 63 of the total 1,484 cases admitted under the IBC have the highly desirable outcome of being withdrawn under Section 12A (withdrawal from insolvency prior to expression of interest stage with consent of 90 per cent of lenders).
- recovery rates are still lower than global averages, and 31 per cent of the 898 ongoing insolvency cases at the end of 2018 have breached the 270-day deadline.
Learning from the mistakes of China
- China can teach us a lot about labour markets but not about banking.
- Their share of bank lending to the private sector has shrunk by 80 per cent since 2013, total bad loans may exceed $3 trillion, and total debt now exceeds 300 per cent of GDP (most loans went to construction because China produced three times as much cement between 2012 and 2016 as the US did in the entire 20th century).
- While China’s treatment of defaulters is tempting — they recently expanded restrictions on travel, buying homes, holding high-level jobs, kids school eligibility, etc for defaulters — these practices are inconsistent with a democracy.
- Over the last three years, India’s bad loan policy moving from deals to rules means the long arc of economic history is finally bending towards justice.
- This remarkable reform will not only recover Rs 3 lakh crore plus for banks but has hugely positive consequences for India’s productivity, wages and prosperity.