Suspension of Insolvency and Bankruptcy Code

Why in news?

The Union Cabinet has cleared the proposal to suspend the Insolvency and Bankruptcy Code (IBC) for 6 months, and it can be extended up to an year.

What is the IBC essentially?

Insolvency and bankruptcy code 2016 was introduced to resolve the bankruptcy crisis in corporate sector.
Under IBC, either the creditor (banks) or the loaner (defaulter) can initiate insolvency proceedings.
It is done by submitting a plea to the adjudicating authority, the National Companies Law Tribunal (NCLT).
According to IBC, a financial creditor holds an important role in the corporate insolvency process.
The Committee of Creditors (CoC) under IBC includes all financial creditors of a corporate debtor.
The CoC will appoint and supervise the Insolvency Professional.
It has the power to either approve or reject the resolution plan to revive the debtor, or to proceed to liquidate the debtor.

What is the COVID-19-led scenario?

Companies are facing significant disruption due to the nationwide lockdown among other COVID-19-related measures.
The government is also working on a special resolution framework for micro, small, and medium enterprises (MSMEs).
The threshold for triggering the insolvency process has been increased substantially for these.
The RBI has also allowed a moratorium on all term loan instalments till August 2020-end.

All the above measures are designed to extend relief to businesses in these extraordinary times.
However, policy-makers would do well to account for the unintended consequences as well.
E.g. banks are worried that the moratorium on repayment of loans could affect the credit culture
It might well lead to higher non-performing assets (NPAs).

How significant is IBC?

The implementation of the IBC is one of the biggest reforms in recent years and must be preserved.
Once economy returns to normalcy, the IBC framework would be required to reallocate capital from weaker firms to more productive ones.
A delay in this process would affect the pace of recovery.

What are the uncertainties with IBC suspension?

In the context of the IBC, it is important that the government involve the RBI and large banks.
They will have to collectively decide on the ground rules with utmost care and clarity.
E.g. if the cut-off date is March 1, 2020 what would happen to companies that might have defaulted before that should be clarified.
Also, criteria for differentiating borrowers hurt by COVID-19 from those impacted by other factors should be specified.
Economic indicators suggest that businesses started facing difficulties much before the lockdown was announced.
So, what will happen to firms that had defaulted and lenders were preparing to start the proceedings under the IBC is a big question.
Notably, the resolution of such accounts will help unlock funds, which can be used by banks for further lending.
In all, resolution might become a bit difficult because of economic uncertainty.
However, it cannot be a reason for suspension.
A blanket suspension would not work as firms facing difficulties may themselves want to file for bankruptcy resolution.

What is a better way ahead?

The Indian economy is largely expected to shrink in the current financial year.
Lower sales and operating profits will make debt servicing difficult.
So a large number of firms may not be in a position to service loans even after the moratorium period.
It is thus widely expected that the RBI would allow a one-time restructuring of debt.
Therefore, the government will need to work with the RBI in framing the IBC suspension mechanism.
The NPAs are likely to rise in general because of economic disruption.
But, policy-makers must make sure that the banking system is not put under excessive pressure.
This is imperative because otherwise it could threaten the country's financial stability and affect economic recovery.
It must also be ensured that IBC suspension does not end up affecting government's efficacy in the medium term.

Source: Business Standard