'No need for Lenders' Liability Act'

On October 8, 2003, Business Standard organised a round table conference with the who's who of India's financial sector. Three top bankers, two corporate chiefs and one representative each of the central bank, the investment banking community and a consultancy firm met to discuss the topic "Do we need a Lenders' Liability Act?"

The participants were A K Purwar, chairman, State Bank of India; K V Kamath, managing director and CEO, ICICI Bank; Sanjay Nayar, CEO, India and area head, Bangladesh, Nepal and Sri Lanka, Citibank; Shashi Ruia, chairman, Essar group; Kishore Chaukar, managing director, Tata Industries; N V Deshpande, principal legal advisor, the Reserve Bank of India; U R Bhat, director and head of equities, J P Morgan, India; and Janmejaya Sinha, director, The Boston Consulting Group.

The discussion was moderated by Tamal Bandyopadhyay, City Editor, Business Standard. Excerpts:

Bandyopadhyay: Welcome to the fourth annual round table of Business Standard. Should there be a law to make lenders responsible for borrowers' needs? Last year Business Standard asked M Narasimham, the architect of Indian financial sector reforms, what he feels about lender's liability. He said: "Let me tell you one thing. Corporations have always come out with a sob story. They are cry babies. After all, borrowing is not their divine right."

That's one extreme view. On the other side, some borrowers "� particularly in the small and medium segment of industry "� blame bankers for not giving money at the right time, thereby killing units. This evening, we would like to see whether there is a level playing field. Has the balance of power tilted in favour of bankers after the Securitisation Act was passed?

Let's start with Deshpande.

Deshpande: Before we explore the need for an Act, look at the legal position. The Securitisation Act was criticised as some borrowers felt that it was loaded against them and so there should be a Lenders' Liability Act. We have to see whether the Act is really biased and is denying certain rights to a certain class of society. We are saying that it is in favour of lenders because without the intervention of the court, they have been given the right to take possession of collaterals and sell them. But these kinds of laws were there in the Transfer of Property Act even before the Securitisation Act.

The English mortgage system permitted the sale of mortgaged property without the intervention of the court. Similarly, for movable properties, the Contract Act provides rights which can be exercised without the intervention of the court. So, is there anything new?

Even under the Contract Act, there is a lender's liability. This is not a new concept. We have a felonious liability, a vicarious liability, a tortuous liability, a direct liability and so on. All these liabilities are there for a lender under the terms of a contract under the existing law. So what's it that we are talking about that should be there?

Sinha: We are seeking an efficient financial system and a credit market. An efficient credit market requires regulation to support market parties which are equivalent in terms of power. If things start going wrong, we should start thinking about laws.

For about 20 years "� from 1969-70 to 1990 "� the banking system was used by the government to grow advances, deposits and branches. A lot of it was under the public sector where there were issues of incentives not being as strong as they could be. So, you had a vigilance apparatus looking over this and the power of the banker was much less than that of the party on the other side of the table.

Since liberalisation began, both the real sector and the financial sector started to undergo a change and international norms of income recognition came. So the government started to focus more on non-performing loans, as did bankers. The quality of lending became important. At that time we started to see that the judicial system was very slow.

There were two issues: how to have an efficient credit market and what is the role of contract enforcement? There is a sluggishness in the court system. The Securitisation Act has moved the balance of power along. The question that we should ask is: should there be a lenders' liability just from the borrower's point of view? Or, from depositors' and equity holders' point of view too?

Has the balance of power moved too much that efficient markets cannot function now? Will the system become more effective and the credit market work better if we have a new law? Is the market power between borrower and lender unequal? Do we actually need a Lenders' Liability Act given that many emerging markets which have faced similar problems with legal systems have tended not to go in that direction? That is the overall context.

Ruia: Following liberalisation, the Indian financial system has been gradually meeting international standards, particularly in the areas of capital adequacy and income recognition and provisions for bad and doubtful debts.

But we have certain unique practices. Take for example, group exposure. Internationally, exposure norms are limited to companies. The Indian economy is not yet totally liberalised. We still have restrictions like borrowing in foreign currency and long term institutional lending for industries and banks funding working capital requirements.

Indian industry has had to face any amount of changes, both statutory "� in customs duties, excise duties, sales tax and VAT "� and currency fluctuations. The rupee has gone up; the import duty rate is down from 90 per cent to 15 per cent; the excise slabs have changed; interest rates which had shot up to 32 per cent now are down to 6 per cent or so.

Any of these factors can affect a business and are beyond the control of the management. Globally, restructuring is a normal business practice and there is no act like the Securitisation Act. But in India, this has been enacted in haste with the objective of speedy legal resolution as the Indian judiciary takes a long time.

One may argue that the lender and borrower are governed by a contract and there is no need for a separate act for lender's liability. In this case, the promulgation of the Securitisation Act itself can be questioned.

How can we suggest that the legal system available under the Indian Constitution does not provide the framework for the resolution of a dispute either way under the Contract Act? Can this not be addressed by the introduction of an arbitration clause under the contract between the borrower and the lender?

If there is an act of criminality on the part of the borrower, there are avenues to proceed against him. Isn't it important, therefore, to show an intent to prosecute people who criminally transfer money from companies to themselves rather than taking the companies to task for defaulting on payments, which may be due to various reasons and other causes?

The other issue is that the borrower in India figures as a person rather than a company. Therefore, lending is restricted to the person and not to the sector.

Sectoral risks have yet to be understood. If somebody is willing to lend to steel companies and the steel industry is doing badly, he is taking an equal risk as the promoter.

The Lenders' Liability Act should provide for certain norms or acts within the contract that address mala fides, political interference or personal prejudice because these are three issues that can vitiate a contract.

Nayar: There is no need for the Act. It's still premature. Everything is stacked against lenders. If you look at history, cases of wilful default and the whole judicial system, there is no question of even discussing a lenders' liability law. We need to have the reverse kind of laws to protect lenders as they have been taken for a ride for too long.

If you want to make the financial system far more lighter in non-performing assets (NPAs) and want a better market for ARCs, a secondary market for debt, you can't have a Lenders' Liability Act as it will completely stymie the process. You have fair practices lending norms, an Ombudsman and the CDR mechanism which is beginning to take shape. So a law is premature in the current context if we want to make the system more efficient.

Bhat: As soon as the Securitisation Act came into being we had a situation where banks started getting re-rated in the market, because the bane of Indian banking for the last decade has been the NPA syndrome. Quite a lot of the NPAs have been cleared and even the public sector banks now have net NPAs as low as 2-3 per cent. The gross NPAs are still high but if we remedy the situation, the market will be willing to reward the banking system even more.

If I could digress a bit from the market angle and address the whole business of lender's liability, let me say that India has always been a capital starved economy. So banks which had participated in the payment system, collecting deposits and lending, were in a privileged position. It was a comfortable oligopoly for quite some time till competition hit them.

If you see the agreements that are entered into between borrowers and lenders, it is very clear who the stronger party is. For example, even today, if you see the banking documents in respect of consumer lending, you would see such horrendous conditions that anybody who reads them will not sign them. It says the interest rates will be decided by the bank from time to time and it is not benchmark related. You have to accept anything that the bank says. You have forsaken your right to even talk about it!

The bank can enforce its security without any consent and this is binding on the borrower and the guarantor. Or take for example, another clause: "The bank can, without assigning any reason, terminate the facility, change the interest rate, decrease the interest limit, require additional security to be furnished, modify any terms and conditions of the agreement and both the borrower and the guarantor shall be owned by this." There cannot be a more unequal agreement than this. On top of that, "All statements of account furnished by the bank shall be binding on the borrower and the guarantor and it shall be conclusive. It shall not be questioned or disputed on any grounds whatsoever."

This does not look like a commercial transaction; it is coercion. The impact of liberalisation has also been asymmetric, unequal and uneven between the borrower and the lender. Typically, the borrower is subject to competition even internationally in a very big way, with tariff barriers and licences being abolished. As far as the lender is concerned, there is nothing like tariff barriers but there is always a regulator who has to give a licence and the licence is given sparingly. Therefore, there is not that level of competition.

There have been quite a few NPAs which have been created on account of delayed decisions by public sector banks. They have not taken decisions on, say, giving an letter of credit or a guarantee. I know a couple of cases where when suddenly the rupee was devalued in 1992-93, there had been forward contracts that had been asked to be entered into which had not been entered into. As a result, huge NPAs were created. There are cases in which everybody has contributed to NPAs and there is no point in blaming just one party.

Despite competition, this does not look like a level playing field. The relationship is unequal. The RBI has come up with a couple of circulars about a code of ethics. But they are basically motherhood statements, 'We shall not kill, we shall not commit adultery,' stuff like that. All these things have no value unless there is an enforcement mechanism.

Kamath: I don't think there is a case for Lenders' Liability Act. I disagree with lot of things which Bhat has said. The banking system has been at the receiving end for too long. It is nice to say that the Securitisation Act is not being anywhere. I want to know about the Board for Industrial and Financial Reconstruction where under any pretext all you guys went in and never came out. You distorted not only yourself but the rest of the playing field, the banks, and you emasculated them. The Securitisation Act was brought in because the system was emasculated.

If it had not been done, we would have destroyed the system. Indeed, there are issues in the real sector which have impacted industry. They go beyond borrowers and lenders. They are in policy changes. It is nice to say that because of lender 'Y', companies have gone down. What about the impact of policy changes? We have gone through a sort of policy change, which few countries have gone through in a very short period. Some borrowers have taken the knock, some lenders too have taken the knock.

We are getting to a system which is getting strengthened by the minute and this is reflected not only in the stock prices of banks but also in the stock prices of companies.

Chaukar: Liability should be on three terms. Is the funding given in time? Are the terms correct? Is the quantum enough? If you look at these aspects, are the borrower and the lender on iniquitous terms? When I was on the side of lenders, I always thought that it was iniquitous. I do accept what Sanjay said but I find it difficult to accept that lenders have been taken for a ride. Lenders lend money on their own in a capital-short economy. You dictated the terms, including conversion of loans into equity.

Post liberalisation, a lot of equity has come into place in terms of authority as well as rights. There are some areas of liability which need to be tackled.

I think Shashi made a very relevant point. Lenders look at us as an individual. They never ever look at us as a limited liability joint stock company with a sectoral risk. Most of us as borrowers have seen that when it comes to deciding the interest rate, it is always the risk of the company and the business. But you cannot eat the cake and have it too.

If it is group exposure, take the group risk. If the group is entitled to a 6 per cent interest rate, give loans at that rate. You cannot say that you will take a project risk on company 'A' where you will charge 17, 18 or 20 per cent interest and if that company does not do well, company 'B' "� the sponsor "� will cough up all the money. That is iniquitous and the issue has to be addressed.

Is the law or a code of ethics a solution? Let the lending terms reflect the credit rating. Do you do that by law? I don't think you can. It has to be a code of ethics.

Is another law going to help? If you asked me as an individual, I will say no as it will lead to further litigation, problems and a lot of things. Our needs are very simple "� timely money, acceptable interest rate and right quantum as required. The banking system in India is mature enough to do all these. I don't think they require an Act.

Purwar: I think Kishore has raised a lot of issues which have to be addressed. But let me take you a little back in time. The kind of accumulation of NPAs which had taken place over the last so many decades is unbelievable. Therefore, there has been a collapse of the system somewhere. You can say that BIFR and a lot of civil proceedings and criminal cases have taken time. But has that yielded any result?

No. Bhat raised the issue of an unequal relationship. I would say that it was more unequal on our part than on the part of the customer because we found most of our customers were in two categories. Either they would adhere by the time, system and schedules or they misuse the system in such a way that they never have to pay.

If we have to go global, this has to be corrected. The steps which have been taken in the last three or four years "� CDR mechanism, the Debt Recovery Act, the establishment of the ARC and the Securitisation Act "� have to be seen in this context.

There was a major problem in the system in the form of a huge accumulation of bad debts. These steps have addressed that basic issue. Now there could be arguments that the quantum of loans should be raised. But would you want the system to collapse? Will you like to kill the hen that lays golden eggs? I am sure this country deserves a much better deal. It must have a banking system which is of global standard and gives services to customers of global quality. All these acts are pushing the system in that direction.

We have to give time to the system. The Securitisation Act is being tested in a court of law. Maybe, it will get fine-tuned. In the process, something else may emerge. But certainly a system which permits a customer to misuse funds and then take the system through a 20 or 30-year process has to be put to an end. No system can survive with that kind of anarchy.

I agree with Kishore that the quantum of loan and timely delivery are the issues which have to be addressed. But in terms of rates of interest, the Indian customer never had it so good. They dictate terms to us.

There is no need for a lender's liability code. Let us push the system towards transparency and fair practices. Anything beyond that is not in the interest of the Indian financial system at all.

Nayar: The retail consumer as well as corporates have a lot of choices. If they are not happy with the fineprint of the account opening form "� which Bhat was referring to "� they can go elsewhere. Somewhere in the middle, the small and medium enterprises (SME) are the ones who are needy. They are growing fast. That is an area where we all need to be more responsible.

Ruia: Frankly, I don't think anybody is taking anybody for a ride. People are reacting to market realities as they develop. Industry was being charged more to compensate for agricultural lending and so on. There have been NPAs when interest rates were ruling at 22 per cent or 32 per cent. I have received a bill at 32 per cent. And they used that to make profit. If you call that an NPA, it's an issue which has to be addressed.

There is no need for an enactment when a contract exists. What is required is the interpretation and resolution of a crisis. Otherwise there is no NPA unless there is a defective intent by the borrower which has to be addressed separately. For a genuine borrower, let's look at the example of the CDR. It has not been enacted but was formed under an RBI directive.

In the last one year, about Rs 40,000 crore worth of loans have been recast. I am happy to note that anyone whom I know who has gone through the CDR is now up-to-date in paying his dues and everybody is happy. It didn't need an enactment.

Deshpande: There is a consensus that international practices should be followed as we are going global. One international practice is to have soft laws. A soft law means a law which can be enforced by an authority having the force of a law. If I issue guidelines which are binding upon the bank, they are a soft law.

Let me say that the RBI's code is not just a motherhood statement. This code of conduct is to be adopted by the boards of all the banks with such changes as may be required by each bank to meet their local requirements. Once it is adopted by the board, it is your own decision.

Coming to the point raised by Chaukar and Ruia that they are looked at as a single individual, I beg to say that this is not correct. If you say that it is a corporate exposure, it is treated as a corporate exposure. If you say it is a group exposure, it will be treated as a group exposure.

But then you should also be prepared for consolidated supervision. For a subsidiary company's exposure, would they allow the security or the books of the holding company to be seen for the purposes of security? It all depends on what you hold out. If you want them to be separate entities for some purposes but group entities for other purposes, it's not done.

Bhat said that contracts are coercive. The corporate lawyers look at your terms. The borrower is not a helpless party signing on the dotted line. However, in the case of small borrowers, there may be iniquitous terms because they don't understand where they are signing. That is where our fair practices code comes in. This is based on the Truth in Lending Act which says that if a borrower comes to you, the lender should disclose to him all the options available to him under a particular law.

Kamath: I want to comment on a few issues. One was the issue of promoter versus company. The point is well taken. Historically these were inseparable. The separation is not done even today in the informed world. Frankly, does the major shareholder in the company behave differently from the owner? He doesn't. He behaves as if the company is his.

I am not commenting on whether it is right or wrong; I am saying that there is a fiduciary duty here and there is a structure here. This differentiation is, by and large, not done in Indian history. I think that realisation is now dawning and with corporate governance coming in, questions are being asked and fingers are being pointed and so on.

As far as lenders are concerned, they need to look at companies one by one; look at the credit ratings and do risk parameter-based lending.

But at the same time, as long as there is this concept that there is a majority holder and "� as Deshpande very rightly pointed out that in most companies you still have a real sector company acting as an investment company "� you cannot separate group lending from individual lending. They need to be separated and fiduciary responsibility has to be cast on the people actually running the company.

The CDR did not work earlier in its different avatar as it was taken for granted. What is now done is that there has to be sacrifice on the part of both borrowers and lenders. If the RBI had not pushed this for almost a year and got all the banks to accept it, this wouldn't have happened. There has to be an equitable sharing of the burden so that if somebody is going to accommodate the borrower, the borrower also has to accommodate by creating a structure which ultimately delivers results.

I want to endorse the fair practices code from the bankers' point of view. A motherhood statement and everything that comes out is a broad statement of intent. Thereafter, it is up to us to articulate how and why we are going about this. Shashi has spoken about 32 per cent interest being paid and booked. I would say book it if it's received.

That is only the first point. The second point is that if this was there, there is a serious question about the fiduciary responsibility of the person who signed this contract on behalf of the borrower. What did he do at the time of signing? Did he not have legal advice? Did he sign against legal advice? That needs to be established. Obviously, the point being made is that it is too high a rate of interest. So, on what basis was this signed? These are questions which will also be raised as we go along.

Purwar: Can the company and its promoters be segregated? We have always believed in the person who is behind the show and trusted him. We take exposure to various enterprises and the person behind the show ensures that the bankers are not put into jeopardy. There are industrial houses that ensure that if a company has gone bad, or if there has been a problem in the company, the liabilities are met on time with interest.

The second point is: why should we see CDR as a step in isolation? Let me tell you Ruia, had the CDR come 10 years earlier, it would have been a flop. It is successful today because you have to see the entire picture. The Debt Recovery Tribunals have become very active; the Securitisation Act has been passed; and ARCs are in place. Let us see the CDR as a part of the total. The CDR will be a success when there are other checks and balances in place and are effective.

Bhat: In the securities industry, over the last 10 years, if any consumer is affected, he has got a quick redressal mechanism because we know that the whole legal system is clogged and there is no point in going to court on anything. There has to be a regulator who will address these issues and give a quick redressal mechanism. That is possible in the securities market today but not in the banking system.

I would say that any code of ethics is a motherhood statement till there is a mechanism to address any excesses that are committed. Can an affected consumer go to the board of directors? Since the perpetrator of the injustice is the same entity, it's very unlikely that you will get justice from them.

Nayar: If you do any more rigid enactment, it will stymie credit flow. It will not come back till you have credit information bureaus which we don't have right now, especially for consumer loans or SMEs.

I don't think there is a big issue of borrowers going under because of untimely disbursement. We talked about these credit information bureaus some time ago but not much has happened on that. Obviously, a lot of banks are not willing to share information. It's not easy. It requires a lot of privacy laws. Unless you have those kinds of mechanisms and go for the Act, it will stop the entire credit flow in the system.

You have some things overseas that are interesting and over time may come here, like Chapter XI, which is very effective. We are not that far away from getting to global standards. The global players too have had collapses. You have had a host of collapses in the telecom industry. But we need some development of deep databases of historical credit behaviour if you want to do anything more drastic than a code of ethics.

Chaukar: Borrowing is not a divine right. I can say that both as a borrower as well as a lender.

I just want to clarify a couple of points about the corporate and the subsidiary the corporate promoted. I don't think there is an issue at all on this. We will consider it with pride if you consider one of the companies promoted by us as our group company.

If you are treating it as a group company for the purpose of the safety of your lending, please give the same terms to that company. If you don't want to give the same terms as that of the sponsor, then feel free to claim a premium. But make sure that the premium is reasonable.

Ruia: There is no conflict of interest between the borrower and the lender. Therefore, bringing an enactment either for the lender or for the borrower does not make sense. All we are saying is that the contract itself should contain a dispute resolution system built into it, which is outside the purview of the courts or whatever it is that takes so long to resolve. Isolated cases of criminality apart, generally there is no ill behaviour by borrowers. So what are we talking about?

Bhat: A code of ethics with a very transparent enforcement mechanism, open to the consumer who can see what is happening is all that we require.

Nayar: There is an equal playing field. A code of ethics is most welcome but if it is there, let it be something which is transparent and which can be seen, felt and applied.

Sinha: I think the pendulum, the balance of power, is swinging towards the centre, which is a good thing. A transparent code of ethics with what Purwar said earlier "� the current laws seeing their full course going through the Supreme Court and getting the sharper edges toned down "� would be useful.

Kamath: The playing field was not level for the lender and tilted in favour of corporate borrowers. But that is getting corrected. It's still not level and may take a little more time.

For the retail borrower, I think it was the other way round. The retail borrower in the past did not have a choice and had to put up with lot of things. That is now getting corrected with new choices.

The code of ethics is there; governance practices are getting tightened and nobody can escape the code. It will have to be self-imposed. The regulatory oversight will be there but ultimately you will have to implement it yourself. If you don't implement it, you are going to be out of the market. This is very clear.

Purwar: We have to get into the international market today. If that is the case, global best practices have got to be incorporated in the Indian system. The balance has been somewhat corrected. But still there is a scope for a code of ethics. I fully endorse the view that it has to be there and it has to be very rightfully, religiously and properly implemented.

Bandyopadhyay: We have a divided house. The bankers feel that they have been taken for a ride for too long and that even now a level playing field does not exist as it is tilted in favour of borrowers. The non-bankers feel the contract is actually coerceon. But all agree that we don't need the Lenders' Liability Act now as it may create problems for the entire credit market.

However, there is indeed scope for having a 'soft law' or a 'code of ethics'. It can even be done through self-regulation or arbitration. Ultimately, the market is the arbiter. If you do not follow the rules of the game, the market will eject you. On this note we will end.

Thank you all.