The Union corporate affairs secretary has been reported as saying that the Insolvency and Bankruptcy Code (IBC) may be amended under a new government after the elections to make things easier for small borrowers. Borrowers who earn less than Rs 60,000 a year, have assets worth below Rs 20,000 and have outstanding loans of less than Rs 35,000 would be eligible for what the secretary himself described as a “loan waiver programme across sectors for small farmers, artisans, micro-enterprises or other individuals”. This new scheme adds itself to the plethora of other such waivers on offer or being promised by various political parties in this election. But it may be even more dangerous than the others on offer.
There is no harm, per se, in addressing the problems that small borrowers face when it comes to personal bankruptcy. People with small-ticket borrowing should not have to deal with an insolvency process that is as rigorous as for large corporate groups. The official also correctly pointed out that it is possible that such small-ticket cases would clog up the IBC system, thereby rendering the resolution of larger and more systemically important cases difficult. These are all issues that must be fixed, perhaps with a more streamlined approach to personal insolvency at low levels of income. However, the notion of a “universal debt relief scheme”, which is how the corporate affairs secretary described the plan, is profoundly dangerous. It will undermine the entire basis of financial inclusion — which is to enable individuals to borrow more for entrepreneurship or consumption. The incentives for banks will become perverse. The official claimed that it would cost only Rs 20,000 crore, but there is no reason to suppose that it could not balloon beyond that figure. It is also easy to game. A question worth asking is: For individuals who have no clear idea of the importance of their credit history, how much is their credit history worth? If his outstanding loan is considerably below Rs 35,000 (the maximum), a borrower may be encouraged to sell their access to the waivable loan to illegal aggregators. As the demonetisation experience shows, there is no clear way for banks to prevent such side transactions.
Another question that must be asked is: Why is a universal debt relief programme being considered at this point? Does the government know something about the state of the MUDRA small-loan programme that is not evident in the publicly available data? There has been an upturn in bad loans in this category of late, but is worse feared in the future? The MUDRA scheme was pushed by the government, over-riding RBI reluctance, and the suspicion is that there has been a political angle to some of the loans given — mostly small amounts that are not worth chasing given the cost, especially in the absence of collateral. A wholesale write-off now would seem like trying to pre-empt criticism of a scheme that clearly has had room for misuse. While there is no question that a better structured way to declare insolvency is required for small borrowers, creating a financial system that reaches out to such borrowers effectively is paramount — and that will require a robust method of ensuring repayment when it is possible. Such a scheme also runs the risk of destroying credit discipline and credit culture, creating problems for the micro-finance institutions via unserviced loans. This might choke a crucial source of credit that is far superior to the moneylender. There is no doubt that there is considerable distress among the poor. But a universal debt waiver will not address that problem properly, the way a direct benefits transfer scheme would.
via Another bad idea | Business Standard Editorials