Banks have several ways of recovering money from a bad loan but how effective are they. This is second part of a four part series
A lending bank is generally capable of detecting the “straws in the wind” about a loan account becoming irregular from its monitoring system and from a number of operational features of the loan account itself. Periodical inspection/visit to the borrower’s place of operations helps in forming an opinion. It is rare that a bank is surprised except where the borrower proves to be totally dishonest or a willful defaulter.
Not uncommonly, a borrower might resort to some deviation to conceal the true state of affairs from the bank, in the hope of remedying the problem on his own or hoping the problem could be temporary, in the apprehension that otherwise the bank could take a serious view and interfere with the operation. Such deviations cannot be ipso facto judged as deliberate actions to cheat the bank.
The bank’s credit officials have to be empathetic to analyse quickly and understand the problem faced by the borrower to find a solution to regularise the loan and get the operations on even keel.
Such an approach is essential to safeguard a basically viable unit of production or services and employment which it generates. It is easy for a bank official to condemn a borrower with punitive actions like filing suits, enforcing security, seeking personal bankruptcy, etc for not adhering to the terms and conditions of the loan, to avoid possible vigilance enquiry against him for making a helpful decision in the reasonable hope that the assisted unit might regain viability which is in the interest of the bank as well. (Please see comments in first part: http://www.moneylife.in/article/indian-banks-npas---i-the-extent-of-the-problem/26929.html ).
It takes a while for the bank to consider a loan account as non-standard and possibly irretrievable, if rehabilitation under close supervision does not succeed. There could be several reasons, such as the borrower is incompetent, the economic activity itself is unviable in the emerging circumstances, labour strife, competition, technological obsolescence, diversion of funds to unrelated activities, etc. In such a case the bank has no alternative but to recall the loan and seek to enforce the security to recover as much as possible.
The process of recovery of the defaulted loans involves one of the two methods; 1) without recourse to judicial process; and 2) through the judicial system. In the first one where the borrower is co-operative, assets charged to the bank are sold by private negotiations or by auction. Personal guarantee is also invoked simultaneously to recover some additional amounts from the borrower’s other sources.
Unless the land and building and other fixed assets are a part of the security in favour of the bank, full recovery of the amount owed is well nigh impossible. Typically in the case of working capital loans, sale of inventory and book debts which form the primary security does not get the realisation to meet the amount due. The bank eventually has to write off the shortfall from the provisions held or from the profit.
The Indian legal system being what it is, banks are hesitant to take recourse to legal action, particularly for smaller loans. Even if a bank succeeds in a suit filed case after a few years, enforcement of the decree becomes cumbersome. Hence, banks are increasingly taking recourse to one-time settlement with the borrowers.
The Reserve Bank of India (RBI) has laid down elaborate procedures on the issue of compromise settlements and every bank tries hard to recover much more than the benchmarked amount. This method has succeeded substantially in that the banks are able to reduce the number of defaulted loans. To cite an example, the annual report 2011-12 of Canara bank reveals that more than 17,000 recovery camps were held which fetched Rs1,575 crore of defaulted loans.
Coming now to judicial processes, some of the special and enabling Acts passed by the Parliament to assist lending institutions in dealing with difficult loan accounts are worth examining in brief.
Realising the seriousness of the problem of sick industrial undertakings financed by the banks, the central government passed an Act known as “Sick Industrial Companies (Special Provisions) Act, 1985 (SICA)”. Under this Act, the Board of Financial & Industrial Reconstruction (BIFR) and an appellate authority known as AAIFR (Appellate Authority for Industrial & Financial Reconstruction) were set up in New Delhi. Under this, every company is obligated to register itself as a sick company once its net worth is completely eroded.
Initially this was confined to public limited companies but later in 1991, public sector undertakings were also included. Detailed instructions are stipulated for the sick undertaking and the lending institutions about their responsibilities. First an Operating Agency (one of the lending institutions) is appointed to make a study and work out a draft scheme to decide on whether it is worthwhile reviving the undertaking and if so with what conditions, reliefs, etc. OR certify the undertaking can be wound up.
No legal action can be taken against the borrower by anyone once an undertaking is under the purview of BIFR under Section 22 of the Act which is considered an essential protection for a rehabilitation of revivable entities. The financing institutions need not necessarily agree to the scheme of rehabilitation.
Over the years, it has been found that the borrowers take full advantage of the protection under Section 22 and carry on their operations, even if truncated, with the help of some other friendly bank or on their own and drag the proceedings in BIFR by seeking adjournments of hearing, going in appeal to the AAIFR on some technicality or the other, submitting unacceptable one-time settlement proposals for a fraction of what is owed with repayment spread over several years.
There are a number of cases pending for five to 10 years; ingenuity of borrowers unwilling to repay the loans and frustrate the legal process under BIFR/AAIFR because of the protection they enjoy under the same Act calls for a separate study. One curious case is that of Scooters India (a PSU), which approached the BIFR twice over the last two decades. This company should have been wound up a decade earlier but it is being revived!
BIFR is also guilty of prolonging the cases—initial acceptance for registration itself could take a year and thereafter permitting series of adjournments. On all counts the record of this Act, in practice, has moved away from the original intention of speedy rehabilitation or expeditious enforcement of measures determined in the proceedings.
Ironically the first objective of the Act is “the timely detection of sick and potentially sick industrial undertaking”. The definition of sickness under the Act is the erosion of 100% of net worth. No sane lender will wait to consider rehabilitation when all net worth is lost for BIFR to step in.
Weary of the record of the performance and representations from the lending institutions, the government introduced a bill called “The Companies (Amendment) Bill, 2001, to provide for establishment of the National Company Law Tribunal (NCLT) and an appellate tribunal to replace the BIFR. Its constitutional validity was challenged in the Supreme Court, which suggested some changes. These changes were introduced in another amendment in 2011 for approval of the Parliament.
In 2003, the government got an act to repeal the SICA passed in the Parliament but it could not be notified as the NCLT could not be formed for the reason stated. BIFR is continuing as usual. Thus for 10 years now, BIFR is hanging out with a success rate of rehabilitation reported to be below 10%.
(A Banker is the pseudonym for a very senior banker who retired at the highest level in the profession)
SEBI asked Jaipur-based NGHI not to collect money from investors under any plan or scheme
Market regulator Securities and Exchange Board of India (SEBI) has asked Jaipur-based NGHI Developers India Ltd (NGHI), its promoters and directors to stop collecting money, directly or indirectly from investors.
SEBI also asked NGHI and its promoters and directors, Pipal Singh, Bakshish Singh and Avtar Singh not to dispose off any property or asset without its prior permission. The company and its promoters are also barred from securities markets.
The Market regulator asked NGHI to deposit the money collected from investors through various plans or schemes in a separate bank account within three days.
According to SEBI release, NGHI was found to be related with Nicer Green Forests Ltd (Nicer Green) which had been held by SEBI vide its order dated 9 November 2010 to have been operating unregistered collective investment schemes (CIS).
Nicer Green was asked by SEBI to wind up its existing CIS and return money collected to investors within one month from 9 November 2010. However, based on a complaint, SEBI said, NGHI was found to letting Nicer Green to substitute the certificates issued to Nicer Green investors with the bonds of NGHI.
"It thus prima facie appears that NGHI is being used by Mr Pipal Singh and Mr Bakshish Singh, directors of NGHI, as a vehicle to subvert the SEBI order against Nicer Green," SEBI said.
NGHI was also prima facie found to be launching, floating and sponsoring CIS in violation of SEBI Act, 1992 and the SEBI (CIS) Regulation, 1999. "It is noted that agricultural lands are claimed to be sold to poor villagers/farmers who invest their hard-earned money pursuant to investment contracts that are in the nature of 'collective investment schemes' of NGHI," the market regulator said in the release.
Seven banks were among the top 10 list of highest mutual fund commissions earned with HongKong Bank, HDFC Bank, Citibank and Standard Chartered leading the pack
Banks lead the list in terms of highest commissions earned. The top five banks with the highest commission earned were Hongkong & Shanghai Banking Corporation (HSBC) with Rs153.98 crore, HDFC Bank and Citibank earned a commission of Rs130 crore each, Standard Chartered Bank and Axis Bank followed with commissions of Rs84.53 crore and Rs59.25 crore respectively, according to data released by Association of Mutual Funds in India (AMFI). Few banks have earned a significant part of their commission from the fund companies of the same group. The commissions earned by the banks compared to the previous year have gone up significantly. However, for top non-bank distributors the numbers are not too encouraging.
The commissions paid out to 403 distributors in FY10-11 amounted to Rs1,770 crore, however, the commission paid out to just 269 distributors (that operated from more than 20 locations) in FY11-12 was as much as Rs1,859 crore. The total commissions earned by the top 10 banks increased by around 20%, whereas that of top 10 non-bank distributors increased by just 2% compared to the previous financial year. The commissions of HSBC grew by nearly 30%, whereas NJ India Invest, which is one of the top non-bank distributors, the commissions grew by a paltry 3.85%. Other top distributors, in terms of commission earned like JM Financial Services, Bajaj Capital, Aditya Birla Money Mart and Karvy Stock Broking earned lower commissions compared to what they earned in the pervious year.
In the list of 269 distributors, the top 25 distributors take around 70% of the total commissions earned. Out of these 25 distributors, 12 are banks which take a share of more than 60% of the commissions.
Most of the commissions earned by the banks are from the fund house of the same group. State Bank of India earned a commission of Rs30.76 crore, of which 91% or Rs28.06 crore came from SBI Mutual Fund. In the same way, Axis Bank earned 59% of its Rs59.24 crore commissions from Axis Mutual Fund and 36% of the commissions earned by HDFC Bank came from HDFC Mutual Fund.
This is something Moneylife had pointed out last year too when the commissions earned were disclosed. Bankers command enormous reach and trust among their customers compared to distributors. All banking processes are geared to maximise sales and profits and this leads to hard selling of products by the so-called “relationship managers (RMs)”.
Not only this, banks have a readymade database of their clients’ personal details and their financial situation, unlike other distributors. Armed with such information it is easy for them to cross-sell financial products such as mutual funds and insurance. This is a means for them to push sales and earn higher commissions. But this selling usually does not take the customer’s interest into account. It is purely driven by commission. Moneylife has covered many such cases in the past.