Sucheta Dalal :Does The Ordinance Empower Lenders? (29 July 2002)
Sucheta Dalal

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Does The Ordinance Empower Lenders? (29 July, 2002)  

It started out with a bang, and hopefully will not end in a whimper. No sooner did the government promulgate the Securitisation and Reconstruction of Financial Assets and Enforcement Security Interest Ordinance of 2002, than banks and institutions went into a frenzy of identifying willful defaulters and sending off recovery notices.

Within two days, IDBI, IFCI and ICICI had drawn up 20 names each; State Bank of India came up with a list of 70 defaulters that it had targeted for immediate action and Bank of India and Bank of Baroda announced similar plans. Finance minister Jaswant Singh did his bit by describing large defaults as a “loot” of the system when he moved swiftly to introduce the Bill in Parliament. We, the hapless people who have watched industrialists loot the financial system for decades stood up to cheer. So much so that we bristled at the mere suggestion that industry associations were lobbying to have the bill diluted. For the first time, government seemed to have given banks and institutions a powerful tool to recover their money. And the number of notices that were drawn up within days after the ordinance suggested that lending institutions actually meant business this time. Unfortunately, things are not looking so gung ho anymore.

Firstly, we learn that much of the lenders enthusiasm has been carefully orchestrated. The government actually issued a letter through Additional Secretary (Banking), asking all banks and institutions “to start with at least 10 existing, operating and smoothly saleable NPAs (Non Performing Assets) not involving more than two lenders with buyers arranged/finalized to take benefit under the ordinance”. This was circulated at what is called the top management meeting held on July 4. In effect, banks and institutions were obeying orders rather than being truly enthusiastic.

Having drawn up the notices, banks are sitting back and worrying about how to give effect to the powers under the Ordinance. For starters, they say that the Reserve Bank of India, which authored the Securitisation and reconstruction ordinance should at least have discussed it with them before it was issued rather than holding a meeting afterwards. Leading bankers say that although the magnitude of NPAs suggest a serious systemic breakdown, the Asset Reconstruction Companies are not really an answer to poor recovery by lenders. As we know, much of the lending and the failure to recover is due to collusion with industrialists or under political pressure.

Banks in particular are uneasy about a few issues. Firstly, that nobody but secured creditors can really expect to recover any dues. Although action under the ordinance needs a consensus of 75 per cent of the lenders, in value terms it is term lending institutions that would call the shots. They are the biggest lenders and also have first charge over the assets. Since realistic estimates indicate that institutions are not expected to recover more than 30 per cent of the value of fixed assets, this would probably leave other lenders, including banks, out in the cold.

A bigger question is what happens after 60 days. Although the Ordinance is enormously powerful, taking over a running company would immediately make the institutions responsible for day to day expenses, completion of ongoing projects, contracts, salaries, infrastructure costs, outstanding liabilities, pension payments etc. Are lenders and their agencies capable of ensuring a swift and smooth sale of assets so that they are not stuck with the asset? We know from experience that the takeover of Malvika Steel and Bellary Ispat ended in their closure because fresh investment from institutions was not forthcoming. In the case of SWIL (formerly Shalimar Wires), ICICI has forked out more money to complete the project in the hope of selling it later.

Unless the Ordinance is used carefully and selectively, public sector lending institutions could only end up nationalising defaulting private companies. Some industrialists whose names are on the recovery list have already approached institutions offering to hand over their beleaguered project and walk away from it. Remember the promoters of Rajinder Steel and its associate company? They simply abandoned the project and left the country. The Ordinance would be effective if it chased asset rich defaulter companies — Premier Auto, Mafatlal Industries and Cable Corporation are some that come to mind. Will lenders go after these powerful groups? We will wait and see. One bank chairman wryly quoted Chief Vigilance Commissioner N Vittal’s favourite story in this context. He says, even in the olden day when Rajas and Maharajas performed lavish rituals to appease the Gods, it was only sheep and goats that were offered in sacrifice — never tigers and elephants. He fears that the Ordinance will indeed be used to go after select small borrowers while the big ones will continue to be protected.

It must be remembered that State Finance Corporations and at one time IFCI and IDBI had similar recovery powers as prescribed under the Ordinance; yet, barring a few exceptions they rarely used them effectively. Part of the problem is that defaulting companies have an arsenal of tricks that can be used to scuttle recovery. Although the RBI is in the process of framing rules and guidelines to give effect to the Ordinance, many doubts need to be cleared immediately. For instance, section 19 of the Ordinance says that if the Debt Recovery Tribunal or Appellate Tribunal holds that possession of assets by the secured creditor was wrongful and directs that the asset be returned to the borrower, then the borrower will be entitled to compensation and costs. While this is obviously a safeguard against vindictive action by the secured creditors, it could easily be perverted and used against the borrowers. In India, we have also seen innumerable examples of defaulters sabotaging bids for properties and assets that are being auctioned by lenders. It would be even more embarrassing if the asset is possessed and sold at a discount and the lender then has to fork out extra funds to return it to a defaulter under orders from the DRT.

The silver lining is that both lenders and defaulters are treading very carefully. The defaulters know that the Ordinance is indeed powerful and could make things difficult for them, while the lenders know that although they are now well armed, it will not be so easy to use their weapons. The sensible ones are using the notices as a threat to force the more recalcitrant defaulters to the negotiating table and cough up some of their dues.

-- Sucheta Dalal