There has been a lot of buzz in the economy in the recent past on the amendment of The Insolvency and Bankruptcy Code, 2016 (IBC 2016). This new legislation is a course correction to resolve the nation’s bad debt problem, which hampers lending and constricts credit for future investment and resultant growth. The whole intent of creating bankruptcy resolution framework was to strengthen the ecosystem, build credibility for countries to invest and businesses to set base, and encourage entrepreneurship.
The code is based on the principle of collective action, and accordingly provides rights to all the key stakeholders. It reorganises and balances the interests of all stakeholders, and seeks to resolve the issues in a time-bound framework, while paving the way for credit availability without impinging on entrepreneurship. It also seeks to establish norms for asset valuation of debtors in a just manner.
The data compiled by the Ministry of Corporate Affairs (MCA) showed that over 2,100 companies have cleared their outstanding amounts, a majority of which came after the government amended the IBC to explicitly bar promoters of companies that were classified as NPAs from bidding for companies where the National Company Law Tribunal, the bankruptcy court, initiated action. The fear of losing control has prompted them to settle their debt of around Rs 83,000 crore, before action was initiated under the newly-enacted IBC.
The RBI’s stress test revealed that under severe macro stress conditions, six banks may end up with capital adequacy ratios below 9% by March 2018. Under such a severe stress scenario, the system-level capital adequacy ratios may decline to 11.2% by March 2018, from 13.3% in March 2017. Large borrowers accounted for 56% of gross advances and 86.5% of gross NPAs of scheduled commercial banks, whereas, top 100 large exposures accounted for 15.2% of gross advances.
A large borrower is defined as a borrower with aggregate borrowing worth Rs 5 crore and above. The quality of assets emerged as one of the key risk factors in the Indian banking sector, as well as the economy. Stressed Assets comprise of NPAs and Restructured Loans. A loan whose principal and/or interest remains overdue for a period of 90 days is considered as an NPA. NPA alone does not communicate the complete story of the asset quality of banks. Some of the loans are restructured by the bank providing the borrowers an additional opportunity, in case of default. This could be in the form of extended time period, reduced interest rate, conversion of part loan into equity or similar such conditions. To prevent this, no new restructuring is now permitted by the RBI.
The Insolvency Code in India constructs a new institutional framework consisting of a regulator, insolvency professionals, information utilities and adjudicatory mechanisms, that will facilitate a formal and time bound insolvency resolution and liquidation process. The code has made it easy to exit or attempt revival of business which shall improve the NPA scenario for the financial services sector. Looking at how it has been elsewhere, Insolvency Codes worldwide have taken time to stabilise. With the right implementation process, it can have a positive impact on the economy. General Motors in the US is one of the biggest bankruptcies filed under Chapter 11 and is an example of how a company under stress due to macro-economic crises can be rehabilitated.
As per statistics provided by the World Bank, compared to other progressive countries, time taken for resolving insolvency or bad debts in India is much higher as compared to established markets. For example, Bankruptcy laws in the UK for decades focused just on liquidation. The Insolvency Act 1986 was introduced with a view to creating a ‘rescue culture’ for businesses.
Until the Insolvency & Bankruptcy Code came into force in India, lenders were exercising recovery proceedings through special laws such as the ‘Recovery of Debts Due to Banks and Financial Institutions Act 1993’, or the ‘Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act 2002’, and restructuring options as per RBI guidelines such as Corporate Debt Restructuring, Strategic Debt Restructuring, Scheme for Sustainable Structuring of Stressed Assets, etc. Due to a set of obstacles, even though lenders had invoked the above listed provisions, the desired outcome on resolution of the debt had not been achieved in majority of the stressed accounts/NPAs. Successful implementation of IBC shall depend on how well the above mentioned risks are mitigated in the future.
Management of NPAs is one of the key focus areas for banks, and needs expertise and diligence in managing the same as there are too many stakeholders involved apart from the lender and the borrower. With every call back of loan on a NPA, there are multiple aggrieved stakeholders, apart from the promoters of the company. Further, there is an increased monitoring of restructuring cases by the regulators to confirm the viability and/or whether the cases are genuine.
In such a scenario, the introduction of Insolvency & Bankruptcy Code is a major milestone and has proved to be instrumental in reducing and cleaning the NPA stress which got built up in the Indian banking system over the last decade.
(The author is Partner at Deloitte India)