Banking Conundrum! What about Lender's Liability?
Published: May 30, 2016
THE Vijay Mallya loan fiasco has been echoing everywhere be it print media, news channels or the ever obstreperous Parliament sessions. Suddenly, all investigative agencies have swung into action and are busy chasing the recalcitrant liquor baron whose Good Times still don't seem getting over. While this may appear to be setting a palpable deterrent precedent for similar willful defaulters or those who are in the making, but if scratched little deeper, these actions would qualify more as knee jerk reactions, far from addressing the root cause of the problem. The issue of demonic rising graph of non-performing assets (NPAs) and willful defaults by businesses has become so omnipresent that it has almost acquired the status of coffee table discussions. The Vijay Mallya episode is an outcome or by-product of the flaws in the system and therefore, in the middle of this upsurge of emotions and aggression, an extremely crucial aspect which is linked right to the core of the problem remains less explored. Yes, it is lenders' liability. While we debate and discuss so much about borrowers' liability, the glass would remain half-full, unless this aspect of the conundrum is adequately addressed.
Background
Lenders' liability, originally an American doctrine, has been traditionally understood in the perspective where the lenders are made liable for any loan made in bad faith i.e., fraud or misrepresentation by the lenders. Back in 2003, the Ministry of Finance had decided to legislate a statute on the lines of America's The Truth in Lending Act, 1968. But no law was made, until the Reserve Bank of India (RBI) came out with Guidelines on Fair Practices Code for Lenders in 2003 (RBI Guidelines). 1 Based on these broad RBI Guidelines, each bank formulated its own fair practice code guidelines. However, these guidelines primarily laid down the code of conduct for lenders while dealing with borrowers and in fact required banks to be sympathetic when borrowers are in distress. Eventually these guidelines turned out to be toothless when pitted against this burgeoning problem as it was never adequate to address this issue. Later in 2004, the echo of lenders' liability was heard in the Mardia chemicals 2 judgment when the constitutionality of the Securitization and Reconstruction of Financial Assets and Enforcement of Security Interests (SARFAESI) Act, 2002 was challenged. The Apex Court did make some observations, but it was in a different context primarily emphasizing the liabilities of the lending banks while enforcing their rights/remedies under the SARFAESI Act. Since then much water has flowed under the bridge and therefore, the concept of lenders' liability argued herein, keeping in view the Indian banking sector, stands on a much different footing. Lenders' liability must call for making the lenders accountable, when banks act negligently or with malafide intention (for instance, indulging in aggressive lending despite knowing the clear and present risks) at the time of granting loans and/or when they fail to take appropriate and timely actions to recover loans from the defaulting borrowers. This article argues that banks cannot be allowed anymore to enjoy the immunity of victim syndrome when they have a contributory role in this worsening scenario.
The flipside of Coin
The past decade certainly shows that the RBI Guidelines have not yielded much result while the NPA problem has spread like a cancerous virus. It is true that since the banks are the lenders, they must be given the prerogative of branding a lender as willful defaulter. It is equally correct that the public sector banks (PSBs) have the onerous responsibility of extending credits in various social sectors which adds to NPAs in their balance sheets. However, at the same time, why no onus is cast upon the lenders, when there is clear deviance from the set governance norms or when there is a clear case of promoting loose credit culture. Several detailed research done in the developing countries indicate that there is a strong co-relationship between urge for profits and willful defaults. Banks often assume informed risk for greater profits, which always has a potential of becoming an NPA in the balance sheet.
Now let's apply the principle of lenders' liability to the infamous episode of Kingfisher Airlines (KFA) which stands as a classic instance of crony capitalism and over ambitious lending. The white paper published in March, 2016 by Switzerland based Trademark Comparables AG (Beyond All Comparables - The case of Kingfisher Airlines) makes an excellent analysis of how the Indian banks have lent loans to KFA on the basis of outrageously inflated trademark valuation. 3 In 2009, Grand Thornton arrived at a magical figure of INR 4111 crore valuation of the brand with respect to KFA, an entity which had never made any profits since inception. To make it more interesting, back in 2009, the brand 'Kingfisher' legally belonged to United Breweries Ltd. and it was only in 2010, when trademarks like "Kingfisher Airlines" and "Kingfisher Express" were applied for trademark registration in the name of KFA. The white paper undertakes a detailed economic analysis based on several comparables in the airlines industry and exposes the glaring flaws in the valuation of the trademark. The brand 'Kingfisher' tried piggybacking on the successful performance of this brand in the beverage sector which supposedly was the sole basis of bullish sentiments of the lending banks to go ahead with the loans. In 2008 and 2010 debt restructuring, KAF offered the brand 'Kingfisher' as collaterals to the banks. However, the Prudential Guidelines on Restructuring dated August 27, 2008 provides that " while assessing the realisable value of security, primary as well as collateral securities would be reckoned, provided such securities are tangible securities and are not in intangible form ". Moreover, the larger question remains ¾ was it correct on the part of banks to rely on standalone brand valuation and accept them as collaterals which was based on exaggerated revenue projections? Did the banks dig deeper into the basis of the valuation which was way above the industry average before approving the loans? If the answer to all these questions is NO, then doesn't this create a case for lenders' liability? As some experts put it lightly that a kingfisher bird can never be a trademark for an airline. The bird flew away and so did the money. The Serious Fraud Investigation Office and the Central Bureau of Investigation are now probing both into the relationship between KFA and Grand Thornton and the valuation of the trademark.
Further, suitcase banking is a practice not uncommon in India and was sufficiently exposed in the Syndicate Bank and Bhusan Steel case. Therefore, lapses on the part of the banks, especially the PSBs banks in undertaking the credit appraisal of the borrowers cannot be ruled out. There is no instance in India unlike developed jurisdiction, where accountability had been apportioned to banks. Research conducted in overseas jurisdiction show that bankers have channelized loans towards unprofitable ventures in the absence of stringent liability and enforcement mechanism. 4 We all know about the good money - about to go bad - rescued by good money - finally goes bad syndrome . In simpler words, where loans are about to go bad, more loan is pumped into the same borrower or some sister concern of the borrower for paying off the previous loan so the banks need not classify the earlier loans as NPAs. Eventually these loans turn bad causing more loss to the banks. 5 This merry go round is also termed as ever-greening of loans, where the epicenter of this vicious circle is often located in political intervention, over-ambitious urge for profits and vested interests. While ever-greening is more common in PSBs, even the private banks who take so much pride in lower NPAs have been party to such nefarious transactions. The Deccan Chronicles Holding fraud case exposed the participation of several private banks like ICICI Bank (INR 490 crores approx), Axis Bank (INR 400 crores approx), Yes Bank (INR 190 crores approx) & Kotak Bank (INR 100 crores approx) lending loans to a high risk entity. But interestingly, while on one hand, banks go beyond their set norms for extending credits to biggies, it cracks whip on an average common borrower at the drop of the hat. The RBI Governor went on record to state that "We do not punish the wrong-doer–unless he is small and weak". 6 No wonder in the case of swashbuckling businessmen like Vijay Mallya, banks waited like a sitting duck till things spiraled out of control. Back in 2013, the then Finance Minister P. Chidambaram also went on record to state that banks are themselves responsible for rising NPAs as many banks have behaved in a soft and tardy manner when it came to recovery of loans from big players. 7 In nutshell, the lenders liability must cover not only due diligence at the time of extending credit, but should also make banks liable for failing to initiate appropriate and preemptive actions, so these problems can be nipped in the bud.
Why smoked glasses?
Another crucial aspect of lenders' liability is all about complete transparency and public disclosure. Most importantly in case of PSBs which are funded by Government, isn't it the duty of such banks to maintain due transparency and face liability in failing to do so? The infamous journalistic expose done by Cobrapost in 2013, revealed participation of bank officials with tax evaders in soliciting clients for depositing black money in bank lockers. 8 Last year in 2015, when few private individuals sought information from RBI under the Right to Information Act, 2005 (RTI Act) regarding reports of the inspections, statements of the bank, information related to their business, actions taken against defaulting borrowers, the same was out-rightly denied by the RBI. The matter went to the Supreme Court wherein the Apex Court strongly reprimanded RBI for protecting certain banks from embarrassment and rubbished the contention that there exists fiduciary relationship between banks and RBI which was canvassed as a strong ground for denial of information under the RTI Act. 9 The Apex Court recently again pulled up the RBI and directed it disclose the names of borrowers who have defaulted loans INR 500 crores or more. The Apex Court strongly criticized the situation where banks let go high profile borrowers off the hook, but poor famers commit suicide on failing to repay meager loans. Recently, there was a sensational revelation that 28 PSBs have collectively written off INR 1.14 lakh crores NPAs between 2013-15. So the obvious question arises who decided to write-off such astronomical figures of loans? When details were sought from these 28 PSBs under the RTI Act to find out about the decision making process, either the banks cited confidentiality obligation or referred to some cobweb of vague panels and delegated committees. In other words, the deception around the term NPAs and their eventual deletion from the balance sheets continues. In nutshell, secrecy in sanctioning of loans, rescheduling of repayment duration, interest rate cuts, no transparency in writing off loans, etc., is an outright anti-thesis of lenders' liability. Why time and again these banks take the shelter of banking secrecy laws like Public Financial Institutions (Obligation as to Fidelity and Secrecy) Act, 1983 to protect none but the defaulting borrowers. What is happening back stage which these banks are jealously guarding?
Is there a way ahead?
The astronomical and threatening figures of NPAs mostly indicate the BLAST FROM THE PAST which is surfacing due to recent push from RBI to the banks to increase their respective provisioning for the bad loans. Window dressing is an accounting tactic which has always been in practice to cover the actual NPAs. So the immediate question arises on the regulatory role of RBI who allowed the banks to hide the real numbers for several quarters. One may argue that lender's liability may deter the bankers to lend freely. Recently, the RBI Governor said that illegality must be probed but lending must not be killed. Another complex question could be how to draw the line of difference between inherent risk in lending business and crossing the line. These questions can be answered by the policy makers only by confronting the bigger question ¾ can we promote unbridled crony lending at the cost of macro-economic losses? Moreover, the majority of instances where the loans have transformed into humungous NPAs have a strong co-relationship with loose credit culture. At times one has to make a paradigm shift to address certain problems, the banking sector conundrum is definitely a fit case for such shift. It would not be wrong to say that both banks and most importantly, the RBI have to shed their ostrich approach and stop pretending that everything is fine. Most importantly, our approach has to be preventive rather than curative which is not possible, unless we have a robust credit appraisal mechanism.
Further, forensic auditors must be given the statutory authority to scan the financial statements of the defaulting borrowers to identify any possible willful default. The discourse of 'name and shame' strategy has not yielded much results and therefore, the focus should be more on devising tangible strategies to recover loans. The much awaited Bankruptcy code 10 has been passed by the Parliament, which is expected to facilitate early detection of loan defaults with its centralized database (information utilities) and swifter insolvency and bankruptcy proceedings. And most importantly, it is high time to put in place a full-fledged mechanism which can clearly apportion liability to banks for any act of malafide /negligent lending and/or inability to act swiftly to recover loans. Huge clouds of deception still surround the whole procedure of writing off NPAs. This has to change and should be replaced with a transparent system which must spell out first , the reasons for arriving at any such final decision, and secondly , the persons behind the key decision. Coming to the KFL case, SFIO and CBI must extend their investigation into the entire process of brand backed financing in the absence of any underlying business, to set a palpable deterrent against any such future lending misadventure. The KFL fiasco has also taught us an important lesson that it is high time now that India must have treaties with foreign nations which can allow us to confiscate foreign assets of wilful defaulters residing abroad.
The existing banking secrecy laws needs to be amended keeping in view the current scenario. 11 There is a constant head on collision taking place between the RTI Act and the multiple secrecy provisions regulating banks. Quite ironically, these secrecy laws are being used more often than not to guard the defaulters rather than safeguarding genuine confidentiality obligations of clients. Therefore, the jurisprudence of banking secrecy laws in India needs to be revisited in view of the looming economic crisis. In sum, suggestions and measures could be plenty, but the vital question is ¾ are we willing to change and act?
Conclusion
In the Union Budget 2016, the FM announced infusion of yet another Rs 25,000 crores 12 towards re-capitalization of the PSBs, which means an extra fiscal burden on the Government. This will have a cascading effect and finally bleed the public at large. Till date, the deposit insurance under The Deposit Insurance and Credit Guarantee Corporation Act, 1961 stands at a laughable sum of maximum Rs 1 lakh. In a situation where any of these banks collapse under the pressure of gargantuan size of growing NPAs, a depositor would get nothing more than Rs 1 lakh. One may refute this argument as hypothetical fear drawing confidence from the age old adage ' Too big to fail ' rationale or may be due to the comfort of sovereign backing in such situation. But looking at the galloping rising graph of NPAs coupled with our rigidity to overhaul the system, we could be heading towards systemic risk. The Supreme Court in Mardia Chemicals judgment categorically stated that while loan transaction is a private contract between banks and lenders but when public money is at stake, private rights have to make way for larger interests. Borrowing this crucial observation of the Apex court in our context, it can be argued that these banks have huge social responsibility towards the public at large and when they have time and again not only failed to check the crisis but also contributed to it indirectly, how long they can only argue for more rights and remedies but shy away from their corresponding liability. With the RBI and PSBs receiving constant hammering by the apex judiciary, the time is propitious to push for a formal scheme of lenders' liability. Finally, the age old veil surrounding the chain of events where loans gets sucked into the black hole called NPAs and eventually vanishes from balance sheets must go. Between the extremes of victimhood and blame games, lies the elusive accountability. This is what our lenders have to own up.
End notes:
1 RBI Notification DBOD. Leg. No.BC. 104 /09.07.007/2002-03, May 5, 2003.
2 See, Mardia Chemicals Limited Vs. Union of India , 2004-TIOL-32-SC-Securitisation.
3 http://www.markables.net/files/Beyond_all_comparables_Kingfisher_brand_valuation.pdf.
4 Banerjee, Sudipto, 'Wilful Defaulter': Name and Shame Strategy V/S Procedural Safeguards. COMPANY LAW JOURNAL, Vol. 1, 2015(January), pp. 1-13.
5Id. at 9.
6http://articles.economictimes.indiatimes.com/2016-01-12/news/69704776_1_rbi-governor-raghuram-rajan-central- bank-compliance.
7 http://articles.economictimes.indiatimes.com/2013-12-14/news/45191294_1_gross-npas-state-run-banks-psu-banks#.
8http://www.thehindu.com/news/national/sting-operation-exposes-three-banks/article4509004.ece#.
9 See, Reserve Bank of India Vs. Jayantilal N Mistry , 2015-TIOL-301-SC-RTI.
10The Insolvency and Bankruptcy Bill, 2015.
11Section 45E of the Reserve Bank of India Act, 1934; Sections 17(4), 20 and 22 of the Credit Information Companies (Regulation) Act, 2005; Section 34A of Banking Regulation Act, 1949.
12 http://unionbudget.nic.in/ub2016-17/bs/bs.pdf, Annex No. III-B to Part A, Allocation of Important Schemes.
