Moody's Investors Service says that India's new bankruptcy code will significantly boost the bargaining power of creditors against large debtors for the resolution of distressed assets.
"The current weak legal framework for asset resolution has been a key structural credit weakness for Indian banks," says Srikanth Vadlamani, a "The proposed new rules address several key inefficiencies in the current resolution regime," adds Vadlamani.
Moody's report explains that the proposed bankruptcy law would:
1) Introduce a unified framework to replace the current collection of separate laws drafted in piecemeal fashion across overlapping jurisdictions
2) Reduce threshold for creditors to invoke the insolvency resolution process (IRP)
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3) Introduce third-party insolvency professionals (IP) as intermediaries to oversee the IRP, replacing the debtor's existing management and operate the company as a going concern upon initiation of an IRP
4) Give creditors overriding authority to approve terms of any restructuring package
5) Limit duration of IRP to maximum of 270 days, after which a company will be automatically liquidated
These features are positive for Indian banks because they will act as an incentive for corporate borrowers to avoid loan default and improve the recovery of assets. In addition to increasing banks' influence over the restructuring process, the mandated replacement of the existing management during the process should act as a key disincentive for debtors to default in the first place.
Moreover, the limited timeframe strengthens the banks' bargaining power over delinquent borrowers.
However, Moody's report also points out that significant infrastructure constraints need to be overcome before the framework can become fully operational, including:
1) Development of the required infrastructure required support new restructuring procedure, particularly legal resources and information utilities
2) Time required for various stakeholders to accumulate the requisite legal experience and precedents for the new system to be fully up and running
3) Limited impact that the new law may have on the liquidation process
Moody's report concludes that the new law may only a have a limited benefit in addressing the current asset quality issues facing Indian banks. In particular, the banks will still have limited avenues available to dispose of distressed assets, and will in general remain reluctant to make appropriate haircuts to reflect their current weak operating conditions.
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