The other side of IBC

Some recent cases have raised doubts about the efficacy of the Insolvency and Bankruptcy Code (IBC). The resolution process of the Videocon group, for instance, is being talked about because the winning bid was close to the liquidation value, and banks were expected to take a haircut of over 95 per cent. Some lenders have objected to the plan and it has been stayed by the National Company Law Appellate Tribunal. The overall recovery rate under the IBC process has arguably been subdued and the headline data suggests that a large number of cases since its inception in 2016 have resulted in liquidation. However, it is important to evaluate IBC’s performance in the proper context.

It is undoubtedly one of the biggest reforms of recent years. The Code filled a critical gap by providing a transparent mechanism to resolve stressed assets. In a functioning market economy, it is vital that firms are able to enter and exit the market with relative ease. This enables capital to be used in the most productive way. It is also important for the system to be able to restructure stressed businesses and facilitate better recovery for lenders. All this was practically impossible before the implementation of the IBC. The Reserve Bank of India (RBI), for example, tried several schemes, such as the Strategic Debt Restructuring Scheme, 5:25 Scheme, and the Scheme for Sustainable Structuring of Stressed Assets, to address the issue of stressed assets before the implementation of the IBC.

The need for a modern bankruptcy law became even more critical after a large build-up of stressed assets in the Indian banking system because of excessive lending, both before and after the global financial crisis, though the actual extent became evident once the RBI started the asset quality review in 2015. The Indian financial system had other problems as well. Evidently, promoters believed that they could remain in control — irrespective of the performances — at the cost of banks, particularly public sector banks (PSBs). Banks, on their part, kept evergreening loans to show a relatively better balance sheet. The government also didn’t have problems because recognition of stress increases the need for capital infusion. But things changed with regulatory pressure and the implementation of the IBC. Possibly for the first time, it became apparent to Indian promoters that they can be thrown out of their firms. To its credit, the government was also willing to clean up the banking system at that time. For instance, it amended the Banking Regulation Act in 2017, enabling the RBI to direct banks to initiate proceedings against defaulters under the IBC.

The provisions related to the corporate insolvency resolution process (CIRP) came into effect in December 2016. According to the available data, a total of 4,376 CIRPs have been initiated till March 2021. Out of these, 2,653 cases have been closed. Resolution plans have been approved in 348 cases, while liquidation was ordered in 1,277 cases. The rest were withdrawn or settled. However, it is important to note that about 75 per cent of CIRPs that went for liquidation were legacy cases from the Board for Industrial and Financial Reconstruction. The value was already destroyed in most cases. Among the cases where the resolution plan has been approved, financial creditors have realised about 40 per cent of the claim, which is about 180 per cent of the liquidation value. Although the overall recovery rate has been lower compared to advanced economies, it is far better than the pre-IBC systems. In 2019-20, for instance, while the recovery for commercial banks under the IBC process was at 45.5 per cent, it was 26.7 per cent under the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act (2002), which itself was an improvement from 15 per cent in the previous year.

Further, there are a variety of reasons why the recovery could have suffered. To be fair, these are still early days, and building institutional capacity takes time. The IBC system had to deal with a large number of cases early on because of higher stress in the banking system and a near absence of an efficient resolution mechanism. Further, it is also important to consider the overall economic environment. The Indian economy was slowing even before the pandemic and firms don’t want to invest in an environment of weak demand. Thus, it is likely that lower demand is affecting the price of stressed assets.

Additionally, the performance of the Code depends on other institutional conditions. Lending standards need to improve, particularly in PSBs. Any restructuring of stressed accounts outside the IBC would not look credible till the performance of PSBs improves. Consequently, everything will keep coming to the bankruptcy courts, affecting valuation and recovery. Besides, recovery depends on the underlying value of assets. If lenders don’t take this into account while lending to businesses, recovery is bound to suffer. PSBs have written-off loans worth over Rs 8 trillion in the last seven years, which is more than twice the amount of capital infusion by the government during the same period. However, this does not mean that the IBC ecosystem is perfect. The average time taken for resolution so far is over 400 days. This needs to be brought down as envisaged in the Code. The government should build capacity in the National Company Law Tribunal to enable more timely resolution of cases. Both the government and the banking regulator should also reduce the level of forbearance in the system as it would hurt the final resolution of stressed accounts.