NPA: The case for mediated settlements

The background – What are bad loans and how have they become such a big problem for the Indian banking sector?

At present, the most serious problem confronting the Indian banking sector is the issue of non-performing assets.

In simple language, the non-performing assets are essentially bad loans. The loans which are not earning any interest for the bank and also where the recovery of the principal sum is doubtful, are known as bad loans.

During the last  one decade, the banks in India advanced a considerable sum as loan to such companies which are now not in a position to repay the loan.

In addition to this, several companies also happened to have malafide intentions with respect to the repayment of the loans. Such companies have been wilful defaulters.

The economic slowdown that persisted after the year 2010 has also complicated the situation. The real estate sector is one of the examples where the slowdown has impacted companies across the board.

What is the present status of the non-performing assets of Indian banks?

The country’s banking sector is severely stressed with one-sixth of the gross advances of public sector banks (around ₹7 lakh crore) being non-performing assets (NPAs).

According to a recent estimate by the Reserve Bank of India, almost half of the total non-performing assets are unlikely to be recovered.

The existing legal methods are inadequate when it comes to recover the loans

There are several legal remedies available to the bank to deal with the bad loans. However, these legal remedies have actually ended in a lot of litigations but the actual recovery of the loan has been very poor.

Existing legal remedies are mainly –

  • Insolvency
  • restructuring of companies
  • Securitisation of debts

The actual experience shows that these methods yield much litigation but insufficient recoveries.

In addition to the legal options, the Reserve Bank of India and the Government of India have come up with some innovative schemes and concepts to mitigate the stress of bad loans in the banking sector.

Two such schemes are briefly described below.

Corporate Debt Restructuring scheme (brought out by Reserve Bank of India)

The Reserve Bank of India (RBI) brought out a Corporate Debt Restructuring scheme for resolution of dues from the larger companies.  These companies account for 70% of the debt portfolio  of the Indian public sector banks. Despite it being a well-structured system, this scheme has failed to deliver substantially.

Another criticism of this scheme has been that it excludes the smaller borrower with loans less than ₹10 crore.

The option of establishment of bad bank (concept floated by the Government of India)

Recently the Government of India floated the idea of a “bad bank”.

Such a bank would be established by the public sector banks, which would hold share in the so-called bad bank. The public sector banks would be called the holding banks.

It was planned that such a bad bank would purchase the large loans from the holding banks. The latter would then have better-looking balance sheets. According to the proposal, the bad bank would then sell off assets to private buyers, who see opportunities for profit-making.

However, it is not clear that how such a bank will be able to remove the problem of bad loans.

Roadblocks to settlement and the need for mediation approach

As already mentioned, the legal confrontation adds to the burden of the banks but does not lead to much effective recovery of the advanced loan.

In the legal confrontation, direct negotiations between bank and debtor hardly takes place or even if it takes place, it is not meaningful. It is seen that the banks demand an amount too high and the borrower offers an amount that is too low.

A mediation approach, where an independent neutral engages with both parties, is more likely to lead to faster and better agreements.

In joint and separate sittings with the mediators, this consensual, non-coercive and confidential process enables the parties to discuss options such as debt concessions, repayment schedules, interest reductions, perhaps even additional credit with safeguards.

Acceptance of the mediation approach

Mediation is now well accepted in India, both legislatively and through extensive use by the courts. Agreements reached through this process are enforceable without difficulty. If the RBI sets up mediation panels consisting of bankers, accountants and experienced mediators, that will provide the required institutional framework and enhance trust and credibility in the process and personnel.

What more needs to be done?

In India, the decision-making in Government and public sectors are often delayed or avoided for the fear of post-decisional retributive action by way of investigation and prosecution by multiple agencies such as the police, the Central Bureau of Investigation (CBI), the Central Vigilance Commission (CVC), the Lokpal, etc. Once initiated, the spectre of lengthy criminal trials looms, accompanied by fear of arrest, denial of bail and public ignominy. Courts respond inadequately — they do not speed up trials or consider bail applications expeditiously or penalise unnecessary prosecution. This inhibits settlements which are in the best interests of the bank but involve some concession or latitude inevitable in reaching the best compromise.

Freedom to take sound commercial decisions must be statutorily structured, else all our schemes will remain useless.

As a safeguard, such a body may be headed with high authority, drawn from the top echelons of the judiciary, the RBI and public sector banks, serving or retired.