Deal making is back-at last!

Deal making in banking is returning after a gap of four years. Banking, not the retail stuff but the kind which gets the economy moving, is classically done through deals struck over convivial lunches and dinners.

It’s tough to make deals in an environment of zero tolerance for corruption

Stung by the proclivity of the Modi government to root out corruption in the banking sector, deal-making of all types – and sadly the delights of lunches and dinners on the corporate account – had come to a virtual stand-still, bringing with it the “peace of the graveyard” to the sector.

Lending, at least in public sector banks, ground to a halt because of poor capital backing for fresh lending – post the 2016 asset review and provisioning guidelines, initiated by Governors Raghuram Rajan and Urjit Patel, just the way it is done in the US. Indian public sector bank managements, acting under the compulsion of RBI directives, did recognize the actual level of stressed assets which escalated them to 12.5% of assets from around 4% earlier.

But, sadly, they had no incentives to do the follow-on work of negotiating with the borrowers to resolve the default lest the inevitable “haircut” or write-off of loans involved in such resolutions, fall foul of the uncertain logic of the three “Horsemen of official doom” – CAG, CVC and CBI, who oversee all cases where public money is used unwisely.

IBC 2016 provided the missing legislative environment for resolution but not the spirit for “deal making”

With the Indian Bankruptcy Code provisions kicking in from March 2016, it became convenient to just pass on the task of resolution to the National Company Law Tribunal. Cases have languished there. caught in the spaghetti of quasi-judicial process. By late 2019 out of 2542 admitted cases 743 had been resolved with an average time taken of 374 days.

The Indian Bankruptcy Code 2016 and the accompanying NCLT process is a welcome addition to the quiver of arrows for resolving loans gone bad. But sole reliance on a quasi-judicial process to make a significant financial impact is like expecting the criminal courts to bring down the crime rate.

At best, the IBC can act as a compelling incentive to bring defaulting borrowers to the negotiating table for resolution. But if bankers are too scared to act and prefer to let every soured loan go for resolution to the quasi-judicial process, the results were always unlikely to be better than in the Debt Recovery Tribunals for recovery of loans. Events since 2016 have shown up the fallacy of relying solely on the NCALT process to resolve bad loans.

The “fear factor” of incipient financial instability fed off the slow pace of loan resolutions

With the economy slowing down through 2018 and 2019 the financial stress spread beyond banks to Non-Banking Financial Companies, severely constraining liquidity for growth. The RBI took corrective steps to enhance liquidity and reduce the repo rate sharply by 2.20 percentage points. but the “fear factor” around financial instability spread to savers and investors.

Supreme Court clips RBI’s wings

In April 2019, the Supreme Court struck down the February 12, 2018 directive of the RBI that resolution should commence instantly on even a single default in loan servicing and cases of more than Rs 20 billion be resolved within 180 days. The rationale behind the judicial verdict was an overreach of its legislative mandate by the RBI without seeking the approval of the government. But it was interpreted as open season for the “old system” of dilatory resolution of stressed assets hoping that the passage of time could revive some of them.

Ministry of Finance censures bank management for slow resolution of bad loans

In February 2020, the Ministry of Finance was provoked enough to pull up public sector banks for “ducking” their responsibility versus bad loan resolution and excessive reliance on the NCLT process. The censure was prescient. Soon after, Covid-19 struck, ravaging corporate and individual fortunes.

Covid-19 creates a deluge of bad loans

To cope with the Covid-18 induced stress, the RBI has now revived the pre-IBC process of resolution through restructuring. There is hardly any option. The NCLT is ill-equipped to handle such cases which may number more than 10,000, even under the constrained RBI norm that only those corporates whose loans were considered “standard” on March 1, 2020 should be taken up for one-time restructuring. This caveat will distinguish between pre-Covid (structural problems) and post- Covid (temporary) corporate sickness.

RBI appoints Kamath Committee (August 6, 2020) to devise a framework for resolution

To provide a defined pathway for resolution and to constrain the discretion available with bankers, which comes with the resolution process, the RBI has also appointed an expert committee chaired by a redoubtable deal maker – M.V. Kamath veteran banker (ICICI and New Development Bank) who negotiated the settlement between the Ambani brothers and therefore has equal salience amongst corporates as he does in the banking world. There are two other public sector bankers and the Indian Banks Association.

A granular, defined path for resolution is necessary to give Bankers confidence against arbitrary penal action

One hopes the Committee will define the resolution process to be followed in a granular manner. The primary purpose of doing so, is to safeguard those bankers who take sensible, commercially defensible decisions with respect to new loans or accepting haircuts on old ones, without them getting into the cross-hair of the “Three Horsemen”. It would be better to over-specify and reduce discretion to the minimum so that bankers have the maximum comfort whilst walking on the path defined by the Committee which would also be blessed by the RBI.

Distinguishing between corporates which can survive and others, whose time is over, is a key variable for allocating scarce capital resources. Of course, sufficient play should be retained to allow “deal-making” to fructify into resolution. Time is of the essence here.

Learning “deal making” from Donald Trump

Should the committee be at a loss on how to devise rules which facilitate the art of deal-making, they could refer to the 1987 book on the subject by Donald Trump, allegedly ghostwritten for him by Tony Schwartz, who post Trump becoming POTUS, now prefers to call it a “work of fiction” ( Trump’s big thought is, however, worth emulating “If you are going to be thinking anyway, you might as well think big”.

The good news is that the RBI is getting its hands dirty by prescribing rules for “deal-making” in loan resolutions. The realization has dawned, finally, that hands-off definition of stern rules for recognition of stressed assets is not enough in an environment, where two-thirds of the transactions are with publicly-owned banks. The late Amar Singh – pragmatic politician and deal maker par excellence, would have concurred.

Also available at TOI Blogs August 8, 2020

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