Dr Rajan's interim solution

Only a strong bankruptcy law can rein in errant promoters

Ever since coming to office, Reserve Bank of India (RBI) Governor Raghuram Rajan has been quite vocal against "freeloaders" who did not honour their debt commitments. That his patience was running out was becoming clear when he referred to promoters who are habitual defaulters as "actual frauds", some of whom have taken assets out of the business. These are strong words even for someone who has acquired a reputation for forthright views. Dr Rajan finally walked the talk on Monday when the RBI announced that lenders could take a majority stake in defaulting companies if a debt restructuring failed. The central bank obviously had done its homework well by taking the stock market regulator into confidence. This is evident from the clause that lenders who acquire shares of a listed company under a restructuring will be exempted from making an open offer. There isn't any doubt that as a policy direction, it is a great move at a time when bad debts have climbed to an alarming 10 per cent of total lending. For it instils a sense of fear of compliance in a borrower and the stake to perform responsibly increases. In short, it forces promoters to have more skin in the game.

But a few important questions remain. First, do banks have the expertise to find adequate talent who can run the business till a buyer is found? Second, the ability of the Joint Lenders' Forum to take such drastic decisions is doubtful. So far, we haven't seen any high performance from the lenders' forum (set up in February last year) that is split between the interests of large and small lenders - a fact exploited by many large industrial conglomerates who have got away by using complex structures to disguise leverage levels, while playing banks off against one another. And third, legal opinion is divided over whether removing promoters from their businesses would stand the scrutiny of law. As Nikhil Shah, managing director of Alvarez & Marsal, a turnaround management outfit, says, while it strengthened lenders, the problem was with the "ability of debtors to litigate". In the Indian scenario, legal forums are slow in giving decisions and the process is incredibly complex.

The consensus seems to be that the Strategic Debt Restructuring Scheme is at best an interim solution. What is required is quicker work towards the new bankruptcy code promised in Budget 2015. A strong bankruptcy law protects the rights of borrowers and lenders, promotes predictability and makes the collection of debt through bankruptcy proceedings more attractive. That's why the interim report of the Bankruptcy Law Reform Committee released in February 2015 said that the degree of viability of a company must be the central consideration for allowing it to be rescued and that an unviable company should be liquidated as soon as possible to minimise losses for stakeholders. Bankers have been asking for this for a long time, as the loopholes existing on account of multiple laws such as Sick Industrial Companies (Special Provisions) Act (SICA) and Board for Industrial and Financial Reconstruction (BIFR) that allowed defaulters to exploit and delay recovery has to be altered. Dr Rajan has done what he could to put the fear of god in errant borrowers; the ball is now in the finance minister's court.