Hope is in the air in the corridors of North Block. There is a feeling that a milestone has been crossed by the passing of the Securitisation Act. In the view from there, industrialists are rascals.
They have milked our government financial institutions, taken their money, stopped servicing their loans and told them to do their worst. The poor, virtuous financial institutions would have loved to take over the defaulters' businesses, but were prevented because law did not allow it.
Now that the law has been put in place, the financial institutions will take away the enterprises from the defaulters and sell them off, get their money back, and their NPAs will evaporate.
Is the mandarins' optimism justified? Securitisation is the wrong word. It means bundling of loans into packets that can be bought and sold. The securitisation act does nothing of that sort.
What it does is to create security -- of a lien -- where there was none. Banks normally give overdrafts, unsecured loans or loans against current assets. A borrower in trouble can easily liquidate current assets. So in effect a bank has no security to fall back on.
What the securitisation act does is to give the banks and financial institutions lien on assets which do not belong to them. And where financial institutions do have a lien, the act allows them to take possession of the pledged assets without going through the rigmarole of liquidation of the borrower firm.
Is this the right thing to do? The creditors of a business fall into a line when it is liquidated. Those who gave mortgages come first, then unsecured creditors, and finally shareholders.
The Act helps government-owned finance providers jump the queue; it thus makes a mockery of the laws of property. It also enables them to bypass bankruptcy procedures: if, after they have milked a borrower, he goes bankrupt, the assets they have already appropriated will no longer be available to share amongst the remaining claimants. In both ways, the act is unjust to and discriminates against private lenders.
The act is of a piece with the one piloted by Manmohan Singh which created debt recovery tribunals. Only banks and financial institutions had access to them. If the DRTs had done their job, government financial institutions would have milked their defaulting borrowers dry, and private lenders would have been left high and dry.
They did not, they could not and they were not. Somehow, DRTs enabled the banks and financial institutions to recover very little money. Why? We have no reliable answers; if I had been in the finance ministry, the first thing I would have insisted on before considering the securitisation bill was to review the experience of the DRTs and draw lessons therefrom.
So one is left with impressions. Mine is based on a few borrowers I know. In almost all cases, the bank or FI did not give the credit it was supposed to.
Project loans are generally subject to milestones: the firm is first given some money; after it shows some achievement, it is given another tranche, and so on. Almost invariably, the lender did not give later instalments, and the business, starved of funds, could not generate revenues required to service the loan.
The DRTs went into the reasons why the lender did not release subsequent tranches, generally found that the lender was at fault, and hence refused to rule against the borrower.
Another reason was the penalties banks routinely imposed on defaulters. No doubt as required by Reserve Bank guidelines, banks charged interest rates of 24 per cent and more on defaulting loans.
At 24 per cent, the principal of an unserviced loan doubles every 3 years and 3 months. If a borrower is unable to pay the principal, he is even less likely to be able to pay a multiple of it.
What a rational lender would do is to estimate how much he can recover from the borrower, and settle at a loss. But taking a loss requires exercise of judgment.
In a government financial institution, the judgment of the official who takes a loss can always be questioned; he can be suspected of having taken a bribe, he can be raided by various government agencies, and his life will be ruined.
The whole point of joining the government is to be provided for life; which idiot will pass examinations, get past Banking Services Recruitment Board, land a prize job in a bank, rise to the top by keeping his head low -- and then offer to take a loss on a bad loan? So bad loans are never settled.
The problem was exacerbated by the fact that big borrowers had borrowed from a consortium of financial institutions. That raised the issue of how the loss would be shared out amongst them. The collective of financial institutions was even less willing to take a loss than a single bank: each institution wanted the other to take the loss.
To cope with this problem, the government created the Board for Industrial Finance and Reconstruction: it was a judicial body, which would apportion the loss between the various government-owned lenders.
It did not work because the incentives remained the same: the financial institutions had no incentive to cooperate in the loss-sharing scheme. Add to that the fact that the incumbent borrower continued to run the business, now with even less access to finance than before, and to make the mistakes that got him into trouble in the first place.
Thus the BIFR was bound to fail. And it did, though it took its own time to do so.
For a reason unclear to me, opinion in the 1990s hardened against borrowers; the result was first the DRTs, and now the securitisation act.
For the securitisation act to succeed, however, it is necessary that the assets that the financial institutions sequestrate find a market at prices that would get them a significant proportion of their loans back.
And who constitutes the market? The industrialists, so many of whom are defaulters. Those lily-white tycoons who have never defaulted will, for that reason, not have the money to buy industrial assets on a large scale. Hence, in my view, the Securitisation Act will not succeed any better than its equally ill-thought-out predecessors, the BIFR and the DRTs.
Broadening the market for enterprises can achieve more than excoriation of errant borrowers can. And that requires faster growth, more competition, more finance for more entrepreneurs -- and an end to the present government-led oligopoly in finance.
