In much of the globe, when a large borrower defaults, he is contrite and desperate to show that the lender should continue to trust him with management of the enterprise. In India, too many large borrowers insist on their divine right to stay in control despite their unwillingness to put in new money. The firm and its many workers, as well as past bank loans, are the hostages in this game of chicken - the promoter threatens to run the enterprise into the ground unless the government, banks, and regulators make the concessions that are necessary to keep it alive. And if the enterprise regains health, the promoter retains all the upside, forgetting the help he got from the government or the banks - after all, banks should be happy they got some of their money back! No wonder, government ministers worry about a country where we have many sick companies but no "sick" promoters.
Let me emphasise that I do not intend in any way to cast aspersions on the majority of Indian businesspeople who treat creditors fairly. I also don't want to argue against risk-taking in business. If business does not take risks, we will not get architectural marvels like our new international airports, the "developed-for-India" low cost business model in the telecom sector, or our world class refineries. Risk-taking inevitably means the possibility of default. An economy where there is no default is an economy where promoters and banks are taking too little risk. What I am warning against is the uneven sharing of risk and returns in enterprise, against all contractual norms established the world over - where promoters have a class of "super" equity, which retains all the upside in good times and very little of the downside in bad times, while creditors, typically public sector banks, hold "junior" debt and get none of the fat returns in good times while absorbing much of the losses in bad times.
Why does it happen? Why do we have this state of affairs? The most obvious reason is that the system protects the large borrower and his divine right to stay in control.
This is not for want of laws. The debts recovery tribunals (DRTs) were set up under the Recovery of Debts Due to Banks and Financial Institutions (RDDBFI) Act, 1993, to help banks and financial institutions recover their dues speedily without being subject to the lengthy procedures of usual civil courts. The Securitization and Reconstruction of Financial Assets and Enforcement of Security Interests (SARFAESI) Act, 2002 went a step further by enabling banks and some financial institutions to enforce their security interest and recover dues even without approaching the DRTs. Yet the amount banks recover from defaulted debt is both meagre and long delayed. The amount recovered from cases decided in 2013-14 under DRTs was Rs 30,590 crore while the outstanding value of debt sought to be recovered was a huge Rs 2,36,600 crore. Thus, recovery was only 13 per cent of the amount at stake. Worse, even though the law indicates that cases before the DRT should be disposed off in six months, only about a fourth of the cases pending at the beginning of the year are disposed off during the year - suggesting a four-year wait even if the tribunals focus only on old cases. However, in 2013-14, the number of new cases filed during the year was about one and a half times the cases disposed off during the year. Backlogs and delays are growing, not coming down.
Why is this happening? The judgments of the DRTs can be appealed to Debt Recovery Appellate Tribunals, and while there are 33 of the former, there are only five of the latter. And even though section 18 of the RDDBFI Act is intended to prevent higher constitutional courts from intervening routinely in DRT and DRAT judgments, the honourable Supreme Court recently lamented that: "It is a matter of serious concern that despite the pronouncements of this Court, the High Courts continue to ignore the availability of statutory remedies under the RDDBFI Act and SARFAESI Act and exercise jurisdiction under Article 226 for passing orders which have serious adverse impact on the right of banks and other financial institutions to recover their dues."
The consequences of the delays in obtaining judgments because of repeated protracted appeals implies that when recovery actually takes place, the enterprise has usually been stripped clean of value. The current value of what the bank can hope to recover is a pittance. This skews bargaining power towards the borrower who can command the finest legal brains to work for him in repeated appeals, or the borrower who has the influence to obtain stays from local courts - typically the large borrower. Faced with this asymmetry of power, banks are tempted to cave in and take the unfair deal the borrower offers. The bank's debt becomes junior debt and the promoter's equity becomes super equity. The promoter enjoys riskless capitalism - even in these times of very slow growth, how many large promoters have lost their homes or have had to curb their lifestyles despite offering personal guarantees to lenders?
The public believes the large promoter makes merry because of sweet deals between him and the banker. While these views have gained currency because of recent revelations of possible corruption in banks, my sense is that Occam's Razor suggests a more relevant explanation - the system renders the banker helpless vis-a-vis the large and influential promoter. While we should not slow our efforts to bring better governance and more transparency to banking, we also need to focus on reforming the system.
Who pays for this one-way bet large promoters enjoy? Clearly, the hard working savers and taxpayers of this country! As just one measure, the total write-offs of loans made by the commercial banks in the last five years is Rs 1,61,018 crore, which is 1.27 per cent of GDP. Of course, some of this amount will be recovered, but given the size of stressed assets in the system, there will be more write-offs to come. To put these amounts in perspective - thousands of crore often become meaningless to the lay person - 1.27 per cent of GDP would have allowed 1.5 million of the poorest children to get a full university degree from the top private universities in the country, all expenses paid.
Edited excerpts from Reserve Bank of India Governor Raghuram G Rajan's speech delivered at the Third Dr Verghese Kurien Memorial Lecture at the Institute of Rural Management, Anand on November 25, 2014
Disclaimer: These are personal views of the writer. They do not necessarily reflect the opinion of www.business-standard.com or the Business Standard newspaper
