The Joint Lender Devastation

When the entire banking industry of a country as large as ours is paralysed to a point where it becomes necessary to empower RBI, the banking regulator, “to issue directions to any banking company(ies) to initiate an insolvency resolution process under the Insolvency and Bankruptcy Code, 2016”, can we agree that further proof of a complete institutional breakdown is unnecessary. How did we ever get to this point?

Allow me my oversimplification for a just cause. Back till Indira Gandhi became quite the flavour of the new socialist deal in the 1970s, India accepted the idea that commercial considerations must drive lending decisions. This changed with bank nationalization which ushered in the age of priority sector lending and the monkey circus her minister Janardhan Poojari called ‘loan melas’. Nationalisation inevitably converted lender decisions into ‘political decisions’ which, if you know your Indian English, means that to get a credit line, you had to arrange a pay-off. Since pay-offs aren’t sensitive to commercial common sense, as many good projects got funding as bad. The bad debts mounted but that apart, even if a project was good, how do you finance a payoff? In the crudest scheme, borrowers over invoiced the project cost, siphoned out money and round tripped the cash into the hands of the lender. If they didn’t build enough of a hedge into their loan requirement, they ended up under-financing their project. Sickness was implicit in this mega bank scam.

It took 40 years for the probity backlash to strike back and much of the credit goes to our judiciary. While that was playing out during UPA- 2, two consequences followed. First, every debtor became a crook till otherwise proven. Court encouraged criminal persecutions became the remedy of choice for this complex problem. Second, since it takes two to tango, bankers began to be viewed with grave suspicion. Only those with really big you-know-whats’ participated in decisions that lend money to anyone. Kafkaesque compliance requirements proliferated like maggots on dead flesh. The larger collateral damage was that a debtor who wanted to settle his outstandings found he had no one to talk to. How was a banker to ever write off part of a debt to settle an outstanding without being accused of corruption? The decimation of the ‘system’ in the ‘banking’ was complete.

If you are not one of those who hate Vijay Mallya simply for his flamboyant lifestyle, you will see how he is the perfect case study of the impact of institutional breakdown. What led to his fall? For those who have not read my column Sky High Crucifixion, it comes down to four factors: (a) Mallya decided to take on a competitor airline which was clearly owned by politicians just because he was in the liquor business and thought he knew how to manage government in a sector that lives from day to day at the mercy of the government. (b)His taking to the skies pronounced a death sentence on Air India forcing that government undertaking to sell tickets at a loss subsidied by tax payers’ money bringing the whole aviation sector to its knees, (c) all of Mallya’s attempts to bail out Kingfisher were thwarted by the aviation minister who announced successive ad hoc changes-by-the-week ‘policies’ which supported the competition and prevented Mallya from getting foreign investment. Needless to state, the policies were reversed immediately after Kingfisher went bust. Ask Vistara. (d) Banks rejected all of Mallya’s settlement offers because no one wanted to carry the can for the decision, putting the Supreme Court in the unenviable position of becoming Mallya’s principal prosecutor. The point is that businesses generally fail for complex reasons and many hands are sullied in the saga. Only village idiots and new age gurus tell you it’s all very simple. The bigger reality is that Mallya remains in the dock because no institution exists to fairly evaluate and act on what he has successively proposed.

To me, the main damage the Kingfisher saga did to the country was to designate the CBI as the official witch hunter for everyone who had anything at all to do with any loan that went bad. Once we got past that point, the demonisation of the commercially defeated inevitably reached its logical culmination with the Insolvency and Bankruptcy Act of 2016. I have recorded my objection to the attitude inherent in this new law in Commercially Sustainable Bankruptcy which I may summarize as follows: (a) If you want to ‘Make in India’, you cannot afford to follow the medieval practice of criminaliing a bad commercial call and throwing the debtor in jail. (b) The coercive nature of India’s compliance regime forces promoters to defalcate funds in the dying moments of their floundering businesses in order only to satisfy the extortion demands of state officials. Businesses will dress up balance sheets before they die. (c) Entrepreneurs are rare and precious to every economy and many advanced economies will hammer revival plans down the throats of bankers and employees to secure the continuing good health of business leaders. Societies that are suspicious of businessmen will end up with none. Bankruptcy laws in advanced economies therefore exist to protect, promote and revive businesses rather than shut them down.

Instead, India has chosen to go down a road where the inevitable impact of unsustainable business losses is its takeover by insolvency professionals who are especially incentivised to break up and sell bankrupt businesses to third parties. The system is also geared up to prosecute all those who have participated in the financing of the business in any capacity whatsoever. Bankruptcy means huge write downs for lenders without exception. Is it then a surprise that bankers are simply not willing to call a spade a spade and get on with the job of restructuring a failed business? Here is the central irony: you can shout from the pulpit that you want to Make it India, but when it comes down to dust, government acts not like a commercially savvy partner of businessmen but as the local thanedar out to lathi charge the stragglers. That’s not the best attitude to have if the economy is what you care about.

Be that as it may, the government has reacted to the banking logjam by empowering RBI to tell the banks when and what decision to take. Let me not labour the point. I completely fail to see how a quicker and more certain death is a better solution to a bad sickness, especially when the doctor is incentivised not to prescribe any medicines. Is that ‘acche din’ or the de-industrialisation of India?

This however, is not the main source of my deep disquiet with the ordinance. Since death to debtors is the primary response of the new bankruptcy law, we now have a new dispensation where the death sentence is pronounced not by those who have the most to lose by doing their deathly duty. It is performed by the regulator who supervises these lenders. At one level, this may be a perfect case of change changing nothing. If bankers are practically public servants petrified of being accused of corruption, RBI officials too are public servants petrified of being accused of corruption. Seen thus, nothing has changed.

But that’s not true. At the elemental level, we must recognize that RBI is an independent regulator thus far and no further and in truth not very far at all. Only the particularly naive will believe that demonetisation was RBI’s call to make. Indeed, Delhi’s chattering classes have long circulated names of the small group of bureaucrats who were privy to the demonetisation decision which we know was taken without reference to the Cabinet. Do we need to ask ourselves who will decide which industrialist gets it in the neck? Not RBI for sure. In itself this may be no problem. No allegation of corruption attaches to India’s widely admired CEO, or those who support his laudable attempt to drag our economy forward. Still the fact remains that the decision to revive or shut down a business will now be taken at the PMO by those manifestly not specially trained to evaluate these choices. Even more worryingly, I doubt that huge liberal democracies have advanced themselves by dispensing with institutions, discarding a plurality of decision making and marginalising regulation as a process. For all the good that is intended to be done, this is a truly scary concentration of power, the consequences of which will be apparent only long after a succession of corporate corpses have long been burnt at the stake.

Originally published on June 04, 2017 in Business Today


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