- The Big Shift in Banking Banks in India have been wrestling with a big problem for some time.
- When a company borrows cash and cannot pay it back the money becomes locked in the asset, which lies idle, while lawyers get rich in court.
- It’s an unpleasant process to endure.
- However the RBI is finally suggesting a significant change, to empower lenders to take control of collateral assets following default by borrowers.
- This move could transform lending in India.
The Big Shift in Banking
Banks in India have been wrestling with a big problem for some time. When a company borrows cash and cannot pay it back the money becomes locked in the asset, which lies idle, while lawyers get rich in court. It’s an unpleasant process to endure. However the RBI is finally suggesting a significant change, to empower lenders to take control of collateral assets following default by borrowers. This move could transform lending in India.
The Essence of the RBI proposal
In the current regime when a company defaults on a substantial loan, banks normally have recourse through the National Company Law Tribunal or under SARFAESI Act. Using powerful legislation, borrowers exploit legal avenues to delay the handover of the asset/collateral, and file appeals to push back legal processes.
The new RBI proposal cuts through this red-tape. It envisages giving the lenders the right to take operational control of the collateral even before the courts give their nod.
Direct Management: Lenders are entitled to enter and manage the collateral asset to prevent value erosion.
Quick Liquidation: Banks can quickly sell the collateral asset to recover dues.
No hiding from the bank: Lenders can prevent borrowers from obtaining stay orders to prevent the transfer of collateral.
Why the regulators are on this path
The banking industry has always battled the problem of NPAs. Although the numbers have improved there are fears about loans that can stall business, which leads to banking caution about financing projects in infrastructure and real estate.
When a project fails due to non-payment the assets lying in the company begin to rot and depreciate rapidly, thereby making them valueless to the lender by the time a bank wins in a protracted court battle. The RBI’s goal is to prevent this situation, preserve asset value and ensure that, “If on day one of default, the bank can get possession, complete the project and sell it on to a new buyer.”
What will it mean for business owners
If you have borrowed extensively you need to be aware that rules are changing. You can no longer pledge a piece of land, default and expect to string the bank along with protracted litigation. This bill gives power to the bank and that means the borrower has to ensure the company’s cash flow and timelines remain aligned, and if a borrower defaults on loans the bank can seize the factory. Business owners will lose their firms to banks if they fail to plan their finances.
Industry concerns about the risk factor
While bankers seem happy with this proposed rule some industry experts are pointing out potential dangers.
Valuation risks: What if the bank assumes ownership and sells off the collateral cheaply.
Excessive recovery: The bank may adopt aggressive means and seize the assets, particularly if a company is facing a temporary liquidity crunch.
Operational issues: A bank expert in finance and accounting, may not have enough experience to operate a factory or a toll road.
Looking to the future
The RBI has called for feedback from industry stakeholders to be submitted before enacting the rule. The regulators clearly believe in ensuring a credit market safe for banks to promote credit flow. The proposal serves as a warning to all borrowers. The days of playing the system are quickly coming to an end, forcing businesses to be financially prudent which is in turn a healthy situation for the economy.