Back the IBC

A new mechanism will only kick the can down the road

The government is reportedly considering lifting the suspension of the Insolvency and Bankruptcy Code (IBC) to enable the resolution of stressed assets. It also plans to deal with stressed sectors differently. Restarting the IBC process will help resolve non-performing assets (NPAs) in the system and enable more efficient use of capital. In fact, an extended blanket suspension should have been avoided in the first place. The pandemic has affected the economy in multiple ways and will have a lasting impact on several businesses. Thus, it is important to have a mechanism to efficiently clean up the system. While the resumption of the IBC process will be a step in the right direction, the overall climate for the resolution of stressed assets in the system is likely to suffer.

The Union finance minister announced in the Budget that an asset reconstruction company (ARC) and an asset management company (AMC) would be set up to manage and dispose of stressed assets. Although the details of the new mechanism are still not very clear, banks are expected to bring in capital for the new ARC and AMC. Further, large loans worth over Rs 500 crore will be transferred to the ARC after making provisioning adjustments in line with the Reserve Bank of India guidelines. Banks would get 15 per cent upfront for the asset transferred and security receipts will be issued for the remaining 85 per cent. How much the banks ultimately get will depend on the recovery from the asset. The argument is that the new system will work because it addresses the coordination problem between banks. Also, the banks will get a better value as firms would be given time and support by the AMC.

All this might look persuasive on paper but is unlikely to work on the ground. It is not clear why banks will put in money in a new entity only to take part of it back while transferring assets. Since the Indian banking system is dominated by public-sector banks (PSBs), which also hold the bulk of the stressed assets, they would have to contribute the most in terms of capital. Thus, it is highly likely that the new institutional structure will have public sector characteristics. It will not be easy to build a talent pool to handle stressed assets in different sectors if the new structure is dominated by the public sector. Further, as the resolution is likely to take longer, promoters of the defaulting firms may continue to run them, which will make the final resolution significantly more difficult. There is also the issue of a level playing field if the central bank allows the new ARC to get exemption from regulations applicable to the existing ones. This would be patently unfair to the existing ARCs.

One of the probable reasons for the new system is to help the government delay capital infusion into PSBs. But that should not be the consideration as the new process will undermine the IBC’s relevance. In fact, what the government should do is to strengthen the IBC by increasing the tribunal strength, among other things. The timeline for resolution also needs to be addressed because the present 330-day deadline doesn’t include the time spent on litigation, which is often long. In the process, the value of many projects gets destroyed. In terms of valuation, things would improve over time as the aggregate realisation numbers are somewhat distorted because of the resolution of legacy cases. In short, setting up a parallel institutional mechanism will only help in kicking the can down the road.