PNB Crisis - Why a commoner should pay his debt!

This is my second article on PNB fraud where I am trying to explain why we cannot do much about Mallyas, Modis and so on. And why, a commoner is forced to be a Lannister (who pays their debt :P) while rich can easily do away with it.

For that, it is very important to understand the difference between the two. A home-loan is taken by an "individual” and it becomes his asset when the loan is paid off. That individual is solely responsible for the repayment of that loan and owns all the gains (or the losses). He has full liability of the loan. On the other hand, corporate loan is issued to a "company" and the assets belong to the firm and its shareholders instead of one individual. In most of the cases, ownership of the proprietor is 51% or less. Point to be noted here is that, the owner and the company are two different entities and there is something called limited liability clause that comes into the picture. In the case of corporate loans, many factors such as Gut feeling, trust, personal benefits, and stakes (vested interest) of the banker play an important role, hence making this a bit complicated.

To summarize, loans are to be paid with future cash flows. Like the house in case of a home-loan, parents' assets in case of education loan, if the cash flow stops, the asset could be acquired by the bank, which is not so simple in corporate loans. The assets of the company are mortgaged with the bank as a security. That is another reason why such cases are usually complicated. 

Generally, immovable possession, such as a house or land, is kept as a mortgage against loans. The financiers have the title of ownership of the asset until the borrowed amount is repaid in full. Upon complete payment of the EMIs, the ownership of the asset is transferred back to the borrower. The assets in corporate loans might include the following: 

1. Real Property (fixed assets): Anything that you can see in the company - factory, Shop, land, outlets or residential quarters - is put under fixed asset. The value is usually taken via third party assessment report. After the housing bubble burst, using land as collateral financing took a huge hit. This asset is not liquid and the cost to sell this asset is very high. Selling assets is not easy either, especially at times like this. Buyers of assets remain unsure if they want to take the extra burden on their balance sheets when cash flows are tight and hence, in many cases, buyers end up disagreeing with sellers on valuations.

2. Business Inventory: Any manufactured product or raw material is an inventory. This is a high-risk asset because the raw materials might not attract many buyers, which means that, the inventory that is extremely valuable for the company might have a zero value for the outsiders. For example, Steering wheel is a crucial inventory for Tata Motors Ltd. However, in-case Tata Motors defaults on its loan, steering wheel is a useless asset for the bank, because, banks cannot recover any money by selling the steering wheels that can go only into Tata cars.

3. Accounts Receivable: For example, a firm gets a big purchase order from a client and do not have sufficient resources or cash to complete that. In such cases (trust), a bank may allow a company to use that purchase order as collateral. This is tricky and might be more difficult because it is harder to authenticate. Now, recovery in this case completely depends on how honest the client of that defaulted company is. Some of the clients always pay on time and that becomes a good asset for the lenders but a lot of time, the client tend to delay payments especially if the supplier is going bankrupt. 

4. Cash Savings or Deposits: Cash is always king. It is a low-risk asset for the lender can directly take possession of all the savings. Cash reserves are usually low among corporate depending on the industry.

5. Future cash flow: This is usually in the case of infrastructure projects where investment opportunity is attractive. In cash flow lending such as Roads, Bridges and Airports, the lender has the first right over the cash flow. The assets in such cases are usually zero and barren land is not considered as viable asset in banking terms. This is more sort of project finance.

6. Personal Guarantee: In several lending, the banks take personal Guarantee from the ultimate owner. Many owners escape this as the bank effectively gains the right over all his assets. However, with new banking laws coming in, banks have been given the rights to attach the property of the ultimate owner. However, these are peanuts as compared to the size of the loan. PS- The owner on behalf of the company signs Loan papers. The legal documents are general security agreement that promises pledging of the assets at margin value. 

Any loan can go bad. Banking is not a science with specific and logical answers. It depends on the banker’s conscious intelligence. Moreover, since there is a human intervention, trust plays the most important role. This is the reason why there are multiple layers of approval for corporate loans (call it a nexus). Political pressure, Greed, target incentive could be the additional deciding factor. Hence, loan needs to monitored and re-evaluated frequently. Few of the reasons why any loan will go bad are-

1. Process Flawed: The valuation process is usually taken for a ride or is rotten. Because of this, undeserving people gets loan and sick and questionable assets are also accepted.

2. Inflated Profitability: Best example if this could be Satyam computers and Kingfisher airlines (Read :P).

3. Government Regulations: Through demonetization, Aadhaar linking, introducing new banking laws, giving more powers to RBI and banks, it has been able to do so to an extent. This has left lesser scopes for culprits to manage funds through jugaads, which was the case until now. Central government is pushing hard to reform banks and bring in more accountability.

Few social media economists are talking about culprits escaping to the foreign lands. Well, it has two aspect – First, fund recovery, and secondly, legal action against the promoters. Most of the people think that funds could have been recovered if they were in India. Regarding former, I do not think we could do anything about the recovery other than attaching promoter's asset even if they were in the country. Because the questionable amount is much bigger than the assets (isn't that obvious?). The second aspect is just to satisfy the poor by punishing a rich. 

The cost to chase these loans will end up being higher than the loan amount. If you have noticed, that is the only thing done in Mallya's case. The story will be repeated for Nirav and Rotomac pens and others who follow. Have you noticed that, there were many education loans defaulters in around 2010ish? Because education loan did not require co-laterals at that point in time. Scenarios have changed now and my father will have to repay if I don't.

To conclude, do pay back your personal loans. You will not be able to escape. Sad, but true!