The IBC is working, but needs to be streamlined further

ANALYSIS
Security guards on duty outside the Reserve Bank of India (RBI) in Mumbai. The IBC and its associated laws have helped banks recover $74 billion of bad debt, including close to $14 billion from accounts that had been written off.
Security guards on duty outside the Reserve Bank of India (RBI) in Mumbai. The IBC and its associated laws have helped banks recover $74 billion of bad debt, including close to $14 billion from accounts that had been written off.Courtesy: Getty Images

India’s bankruptcy code, which completed five years recently has achieved a recovery rate of 45 per cent and has improved the credit climate in the country. But it still has some loopholes that the government is expected to plug in the coming months to make the law more comprehensive.

The Insolvency and Bankruptcy Code (IBC), the Modi government’s flagship legislation to ease bankruptcy resolution in India recently completed five years. Critics of the Modi government have had a field day carping mainly about two issues – the large haircuts that banks have had to take while resolving a few high-profile cases and the losses suffered by unsecured creditors and employees.

But all these critiques tend to miss the woods for the trees. It completely ignores the fact that the IBC and its associated laws have helped banks recover $74 billion of bad debt, including close to $14 billion from accounts that had been written off.

Then, total recoveries under the IBC process, at 45 per cent of outstanding claims, according to the Reserve Bank of India (RBI), is almost double the recovery rate of 26 per cent under the Debt Recovery tribunal (DRT) or Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest (SARFAESI) Act, 2002 route, which preceded the new bankruptcy code.

But more important than the resolutions themselves is the marked improvement in the credit climate in the country following the implementation of IBC. Although exact figures are not available, several bankers and corporate executives said the insertion of Section 29A in the Act, which bars defaulting promoters from bidding for their own or other companies, has prompted many till recently errant borrowers to come forward to regularise their accounts.

Indian finance minister Nirmala Sitharaman with RBI Governor Shaktikanta Das. The important factor to consider is the overall record of IBC in assisting recoveries and in improving the credit climate in the country. On both these counts, the results have been satisfactory.
Indian finance minister Nirmala Sitharaman with RBI Governor Shaktikanta Das. The important factor to consider is the overall record of IBC in assisting recoveries and in improving the credit climate in the country. On both these counts, the results have been satisfactory.Courtesy: ANI

Health of banking system has improved

Then, there are also indications that despite the economic disruptions over the past 15 months caused by the Covid-19 pandemic, the build-up of non-performing assets (NPAs), which is Indian banking lingo for delinquent loans, has been lower than anticipated, leading to an improvement in the overall health of the banking sector.

Total recoveries under the BC process, at 45 per cent of outstanding claims is almost double the recovery rate of 26 per cent under the Debt Recovery tribunal or the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 route, which preceded the new bankruptcy code.

“Overall, despite the pandemic, the turnaround is remarkable for public sector banks. The recent reforms and the proposed asset reconstruction company will help clean up their balance sheets further and make fresh capital available from the sale of bad assets, which will again push credit growth,” a senior finance ministry officer told the media.

The Indian banking sector has a provision coverage ratio of 83.7 per cent. This means the lenders are well placed to deal with any defaults on their existing loan books.

A report by leading brokerage firm Macquarie said the recovery rate of 45 per cent falls sharply to 24 per cent if the top nine cases are excluded. “A careful examination of data released by Insolvency & Bankruptcy Board of India (IBBI) reveals that recovery rates are swayed by the top nine accounts, barring which, the recovery rate is just 24 per cent under IBC,” said report.

But this logic is fallacious because the no law can guarantee equal resolution of every case that is instituted under it. There will be cases where banks will recover a larger proportion of their exposure to the defaulting company and there will be instances where the salvage ratio will be poor.

The important factor to consider is the overall record of IBC in assisting recoveries and in improving the credit climate in the country. On both these counts, the results have been satisfactory.

Resolution of high-profile cases has a demonstration effect

Then, resolution of large, high profile cases involving defaults running into several billions of dollars, like Essar Steel, Bhushan Steel, Bhushan Power & Steel and a few others has had a demonstration effect that is discouraging smaller players from wilfully defaulting on loans – the fear of losing control over their companies is forcing many promoter groups to behave more responsibly than before.

Despite these successes, there remains considerable scope to streamline the Code to improve its functioning.

The pace of resolution is still quite slow and the norm on resolving cases within 270 days is observed more in its breach. The Macquarie report quoted data from the Insolvency and Bankruptcy Board of India (IBBI) to show that of the 4,300-odd cases that were admitted under IBC since 2017, only 8 per cent have been resolved and 40 per cent are still pending.

Then, another 1,277 cases, accounting for about 29 per cent of the total, ended in liquidation because they could not be resolved. It must be noted here that 946 of these liquidated companies, or almost 75 per cent, were non-operational at the time of their admission into the IBC process.

Resolution of large, high profile cases involving defaults running into several billions of dollars, like Essar Steel, Bhushan Steel, Bhushan Power & Steel, etc., has had a demonstration effect and is discouraging smaller players from wilfully defaulting on loans – the fear of losing control over their companies is them to behave responsibly.

Some promoters are gaming the system

Two recent cases have shown that some defaulting promoters have gamed Section 29A, which bars defaulting promoters from bidding for their companies, by relying on Section 12A, which allows a company to come out of bankruptcy proceedings if 90 per cent of creditors agree to it.

Some promoters, such as those of Siva Industries and Holdings Ltd and Dewan Housing Finance Corp. Ltd (DHFL) managed to place enough legal hurdles in the path of the resolution process to discourage other bidders for their companies.

Two recent cases have shown that some defaulting promoters have gamed Section 29A, which bars defaulting promoters from bidding for their companies, by relying on Section 12A, which allows a company to come out of bankruptcy proceedings if 90 per cent of creditors agree to it.

Then, Siva’s former promoter offered to settle its $667 million outstanding dues at $67 million, or 10 per cent of the default amount. Since this was more than the liquidation value, the creditors agreed.

In the case of DHFL, the erstwhile promoter came up with an offer of $12 billion, after the $4.9-billion bid by Piramal Enterprises had been approved by RBI and the Competition Commission of India (CCI). The National Company Law Tribunal (NCLT) order asking the creditors to consider the offer has been stayed by the National Company Law Appellate Tribunal (NCLAT). The matter is now before the Supreme Court, which will decide the matter in due course.

Government to plug loopholes soon

The government is watching the proceedings very carefully and will take a view on plugging this gap, which poses a moral hazard of wilful defaulters siphoning money out of their companies and then returning as promoters by clearing only a fraction of their dues to the banks.

These and other shortcomings will be addressed by the government soon. But despite these flaws, IBC has provided a framework to resolve corporate bankruptcies far more expeditiously than all previous laws. And this has contributed immensely to improving the business climate in India over the past five years.

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