Do ‘Bad Loans’ have a Future?

By Tarun Bhatia, MD and Head, Kroll South Asia

Do ‘Bad Loans’ have a future – at times I find it strange answering this question. No system wishes for bad loans, but they are a reality. While bad loans indicate credit decisions gone wrong, it is equally a reflection of risk-taking culture. You need to take risks to earn the rewards, especially in a fast-growing economy like India and hence ‘bad loans’ are not necessarily bad. The challenge in India, however, is that a sizable proportion of the bad loans reflect inadequate diligence, compromised credit monitoring, and often, fraud. Over the last 30 years, India has witnessed a significant rise in non-performing loans every 5-7 years due to the above factors combined with domestic and/or global stress events.

In 2002, with the introduction of asset reconstruction companies, one thought that the Indian financial system had found the necessary solution for resolving bad loans and helping banks raise the much-needed capital. However, fast forward twenty years, and nothing much changed with the market eagerly waiting for National Asset Reconstruction Company (NARCL) to start functioning and bring respite to the large NPA problem which has engulfed Indian banks.

In practice, whether NARCL is a viable long-term solution remains a question mark though it has more teeth with the security receipts (85% of value) issued by them being guaranteed by the government. How NARCL deals with the portfolio of bad loans is, however, of immediate interest and will set the tone for the future. Bad loans acquired by NARCL will have a strict five-year timeline for resolution after which the guarantee would be taken away. Empirical evidence does not suggest that five years might be adequate but there is hope.

The introduction of the Insolvency and Bankruptcy Code (IBC) in 2015 changed the way Indian companies and creditors approached NPAs. For the first time, promoters lost control of companies with creditors being in the driver seat. While the jury is still out on IBC, given low proportion of resolutions and relatively lower recovery rate, IBC should still be seen as a win. It created an alternate channel for resolution, allowed for structured liquidation and most important brought about a culture change when it came to NPAs.

Going forward, banks and other lenders will have to decide if they opt to transfer bad loans to NARCL or try and recover directly. One hopes that there is little external (political) intervention and creditors can take independent calls. Similarly, using NARCL only as a parking vehicle would be a missed opportunity. Instead, NARCL should be allowed to look at innovative solutions to get the best returns.

One such option is Litigation Funding. India has still not embraced litigation funding but there is a developing interest in the concept. In simple terms, litigation funding is a concept wherein a third party (litigation financiers) finances a dispute or lawsuit in exchange for a pre-agreed share of the final settlement, assuming they win. Litigation funding is becoming more prominent in the west – as per a recent report by Research Nester, the size of the Global Litigation Funding Investment Market is estimated to cross USD 13 Billion in 2021. There have been few takers for such services in India so far.

However, rising costs towards recovery and a poor track record is motivating banks to be open towards litigation funding. The concept gained further legitimacy when in 2018, the Supreme Court of India, in Bar Council of India v AK Balaji (2018) 5 SCC 379, observed the legal permissibility of third-party funding in litigation and clarified that legal financing agreements are not prohibited in India. Previously, litigation financiers have also been hesitant in funding Indian litigations – due to the long litigation process and possibilities of multiple stays and overruling.

Tarun Bhatia

But with strengthening case laws due to IBC and the increasing number of NCLT benches, this view is slowly changing. Litigation financiers have been much more open to participating in and founding litigations on Indian borrowers in overseas jurisdiction – NPAs of borrowers with meaningful global operations can be a prime target. We want Indian banks and NBFCs to lend – it’s a key ingredient for growth for Indian companies. We also want them to take legitimate risks. NPAs or bad loans are as much a part of the ecosystem as is inflation. Rather than creating a stigma against bad loans, we need to encourage the themes of diligence and resolution and make use of multiple options available to recover.

I recently saw the hit Bollywood movie Lagaan with my kids and one dialogue aptly resonates the catch22 for Indian lenders – “Chulhe se roti nikale ke liye, chimte ko apna mooh jalahe padi” (To remove the bread from the burner, the tongs must burn their face). I hope they also emerge victorious as Bhuvan and the team from Champaner.

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