Tag: ibc

Bad Bank

Have u ever heard of bad bank? Well, in this article we will know about what bad bank is and how is it taking shape in India. 

So to start over, A bad bank is a financial entity that was formed to purchase the risky loans and other illiquid assets of another financial institution. The company with many nonperforming assets will sell them to the bad bank at market value. The goal of Bad Bank is to bring financial stability to the banking industry. It would store bad loans for public sector banks, which will be offered to investors at a discount which will eventually assist banks in cleaning up their balance sheets. 

Recently, Nirmala Sitharaman, the Union Finance Minister, has announced the establishment of a bad bank in the nation. Sitharaman said in her budget address that an Asset Reconstruction Company Limited and an Asset Management Company will be established to manage the bad debt of public sector banks such as the State Bank of India, Punjab National Bank, and others.

However, Experts were perplexed by this because IBC known as insolvency and bankruptcy code was considered to be pretty efficient in settling problematic debts. But the government was concerned about delays and low asset realization under the IBC. Furthermore, the loans were offered at steep discounts. The assets were liquidated in some circumstances. There were also issues regarding the public sector bank’s(PSB) lack of cooperation. 

So, to consolidate and take over the current stressed debt, an ARC and AMC will be established. It will then manage and sell the assets to Alternative Investment Funds and other potential buyers in order to realize their full worth. To put it another way, it will store bad loans for public sector banks, which will subsequently be sold to investors at a lower cost which will aid in the cleaning up of the balance sheet and will eventually lessen the financial burden of future capital requirements. So, India’s bad bank is now taking form. With the formation of the National Asset Reconstruction Company Ltd, the much-anticipated wait for the “Bad Bank” came to an end. 

Given its size and development potential, the Indian economy will experience a steady supply of distressed assets. When the one-time loan arrangement finishes, Covid-19 will be a source of concern for many businesses. For public sector banks, the existing portfolio of problematic loans is a major source of concern. As of September 2020, the banking system’s total gross nonperforming assets (NPAs) accounted for 7.5% of the entire loan book. 

This is anticipated to rise to 13.5 percent by March-September this year, according to the Reserve Bank of India (RBI). Moreover, Many people believe that running a bad bank successfully necessitates a variety of factors. One, it must be for a defined purpose and include a time limit. For instance, Sweden AMC, supported by the government, recovered over 90% of bad loans in six years in the early 1990s. However, the Chinese AMC, which is supported by the government, failed to deliver. Now it’s up to NARCL, private ARCs, and IBC to preserve the value of stressed assets by restructuring and resolving them in a timely manner.

Role of IBC in the credit sector

 

                                                                (Photo: SignalX)
As per the Reserve Bank of India (RBI), India’s banking sector is sufficiently capitalized and well – regulated. Credit, market and liquidity risk studies suggest that Indian banks are generally resilient and have withstood the global downturn well. The Indian economy is a mixed economy. It is known to be the world’s sixth largest in terms of nominal GDP. The legal environment plays a vital role in the economic development of a country.

After GST, IBC is the second most crucial reform in the legal setting of India. It was implemented through an act of Parliament. The law was necessitated due to huge pile up of non-performing loans of banks and delay in debt resolution. Insolvency resolution in India took 4.3 years on an average against other countries such as U.K (1 year) and U.S.A (1.5 years), which is sought to be reduced besides facilitating the resolution of big-ticket loan accounts. Two years on the IBC has succeeded in a large measure in preventing corporates from defaulting on their loans. The IBC process has changed the debtor-creditor relationship. A number of major cases have been resolved in two years, while some others are in advanced stages of resolution. 

With a strict 180+90 days ‘resolve-or-liquidate’ diktat, the Code has received commendation, not only from the Indian Industry, but from the global fraternity, including The World Bank and IMF, and has materially contributed to India’s 30 place jump in 2018’s Ease of Doing Business ranking. IBC truly enforces the concept of ‘creditor in control’ instead of ‘debtor in possession’, and maximize value recovery potential corporate debtors.  “Capitalism without Bankruptcy is like Catholicism without Hell,” said Frank Borman, renowned astronaut and erstwhile chairman of a failed US airline. As such, the institutions established by the state should promote freedom to start a business (entry), to run the business (level playing field) and to exit/discontinue the business. The reforms of the 1990s focused on freedom of entry (dismantling the license-quota raj) and then, from the beginning of this century, the focus shifted to freedom of continuing business. The third leg, which is freedom to exit, has now been provided in the shape of the IBC, to provide a mechanism to stressed businesses to resolve insolvency in an orderly manner.

The IBC seeks to consolidate scattered and unstructured jurisprudence on insolvency prevalent in various Acts, like the Presidency Towns Insolvency Act, 1909, Sick Industrial Companies Act, 1985, Limited Liability Partnership Act, 2008, Companies Act, 2013, etc. On the positive side, we have witnessed that debtors were reconciling with the ‘creditor in control’ scenario, with the committee of creditors (CoC) becoming all- powerful in the resolution process.

It was the first time that the government and Reserve Bank of India were on the same page for effective resolution of the problem of bad debt and improving overall financial discipline in the way business is conducted in India. As Nelson Mandela said, “I never lose; I either win or I learn.” The jury is still out on the IBC even though the World Bank has acknowledged the efforts.

WHAT IS INSOLVENCY AND BANKRUPTCY CODE, 2016?

“In One line we can say that in case of a default by the equity owners to meet their debt obligations, control is transferred to the creditors and equity owners take a back seat.”

The insolvency and Bankruptcy code, 2016 (IBC) is the bankruptcy law in India and whose aim is to consolidate the existing framework by creating a single law for insolvency and bankruptcy and amend the laws relating to the entities in India with the time being enforce. The consolidation of laws in India is not a new concept like GST was framed by consolidating 17 laws into one. This code was introduced in Lok Sabha in December 2015. It was passes by Lok Sabha on 5 May 2016. 

The purpose of this act can be divided into the following two goals:

 1. Making sure that the insolvency proceedings can be completed within a minimum amount of time.

 2. Making sure that the financial risks to the foreign investors is decreased.
Its primary goal was to consolidate insolvency resolution process for LLPs. Companies, individuals and partnerships.
 That being said, the purposes of these codes, being a part of The Companies (Amendment) Act 2017, are the following:

 1.  Establishing and amending the laws associated with reorganizing and resolving the insolvency of entities like partnership firms, individuals and corporate persons.

 2.  Providing resolution in a time bound manner.

3.  Promoting entrepreneurship in India.

4.  Maximizing the availability of credit in the Indian market.

5.  Establishing Insolvency and Bankruptcy Board in India.

The four pillars of supporting institutional infrastructure, to make the Insolvency and Bankruptcy Process work efficiently are:

  1. The regulator – The Insolvency and Bankruptcy Board of India (IBBI)
  2. Adjudicating Authority (AA):
    1. National Company Law Tribunal (NCLT) – For Corporate, i.e., Companies and Limited Liability Partnerships
    2. National Company Law Appellate Tribunal (NCLAT) will act as Appellate Authority.
    3. Debt Recovery Tribunal (DRT) – For Individuals and Unlimited Partnership Firms
  3. A private industry of Insolvency Professionals (IPs) with oversight by private Insolvency Professional Agencies (IPAs)
  4. A private industry of Information Utilities (Ius)

THE ROUTE TO THE IBC

The main objective of the act is to consolidate and amend the laws relating to reorganization and insolvency resolution of corporate persons, partnership firms and individuals in a time bound manner for maximization of value of assets of such persons, to promote entrepreneurship, availability of credit and balance the interests of all the stakeholders including alteration in the order of priority of payment of Government dues and to establish an Insolvency and Bankruptcy Board of India, and for matters connected therewith or incidental thereto.

IBC provides for a time-bound process to resolve insolvency. When a default in repayment occurs, creditors gain control over debtor’s assets and must make decisions to resolve insolvency. When a default in repayment occurs, creditors gain control over debtor’s assets and must make decisions to resolve insolvency. Under IBC, debtor and creditor both can start ‘recovery’proceedings against each other.

 

It is a comprehensive Code enacted as the Preamble states, to

“consolidate and amend the laws relating to reorganization and insolvency resolution of corporate persons, partnership firms and individuals in a time bound manner for maximization of value of assets of such persons, to promote entrepreneurship, availability of credit and balance the interests of all the stakeholders including alteration in the order of priority of payment of Government dues and to establish an Insolvency and Bankruptcy Board of India, and for matters connected therewith or incidental thereto”.

The Preamble clearly states that the legislative intent to incorporate this code is

Firstly, to remove the ambiguity that had been prevailing in the previous legislations;

Secondly, to prevent unnecessary delays and to ensure fast dismissal of matters, i.e., within 180 days;

Thirdly, to prevent loss to corporate creditors due to depreciation of assets of the insolvent company;

Fourthly, to establish a balance among the interests of the various stakeholders, and

Lastly, to create a common forum to deal with such matters.

IMPACT OF IBC

The Covid-19 pandemic has been driving corporate failures around the world, including in India. The global financial news reveals an increase in bankruptcies due to the Covid-19 induced global lockdowns. While the bankruptcies are unfortunate, a recognition of the bankruptcies facing companies in the face of the collapse and an efficient resolution of such bankruptcies (which will allow both the companies and creditors involved to move along) is vital to rejuvenating the economy.

 In the light of the Covid-19 pandemic and business failures globally, it is important that financially distressed companies can still access the credit market thanks to a strong bankruptcy system and survive under stressed scenarios. Using a panel of 33,845 non-financial firms for the period of 2008-19 and by exploiting a difference-in-differences analysis, a study has been undertaken revealing the impact of the IBC policy on the availability of long- and short-term financing for, and the cost of, credit of distressed firms as compared to their non-distressed counterparts. As in most emerging markets, India’s debt market is dominated by state-owned banks and the domestic credit to private sector by banks (percentage of GDP) is 50 per cent in 2019 compared to a world average of 90.5 per cent (Source: World Development Indicators). Recent statistics from World Bank’s Doing Business Data show the creditor rights index in India improving from 6 in 2014 to 9 in 2019 compared to the world average of 5.67 in 2019.

Bose et al. (2021) study shows that after the introduction of the IBC reform, the access to long-term debt increased by 6.3 per cent, short-term debt increased by 1.4 per cent, while the cost of borrowing declined for distressed firms. This is the first study that provides evidence on the impact of the IBC policy on the “credit channels” of distressed firms. The enactment of the code has helped to enforce discipline in the country’s credit culture. IBC has created a credit culture that discourages defaults. There has been a change in the business culture as well: there is now an understanding that when things go wrong, companies will not get an automatic rescue package from the taxpayer funds. The objective of IBC was to create conditions so that credit could be generated from the domestic market and investments drawn from the international market. In order to achieve those objectives, it was necessary to create a culture of deterrence against default. The practice of dragging lenders to court to delay the repayments of outstanding loans is slowly coming to an end. India’s Insolvency and Bankruptcy Code is ensuring that lenders get repaid on time and this is making India a more attractive investment destination.

IBC has played a great role in macroeconomic objectives providing India a strong stand in the global platform. After the enactment of the code, the FDI has substantially increased. In 2012-13, the FDI of India was 34298 US$ Million and just after enactment of the code it rose to 61463 US$ Million in 2017-18 which is growing by approximately 80%. There has been an increase in Mergers and Acquisitions activity in the country. It also led to the establishment of Information Utilities (IUs) which further accelerated the development of the credit market of India.

In previous, no law prevented the operational creditors but under the code, there is a provision that the operational creditors (domestic as well as international) have right to file suit against the default. Thus, the code provides right to the foreign creditors which will enhance the economic transactions of India and others.

 MEASURES TAKEN DUE TO COVID

The global COVID-19 pandemic and its consequential lockdown are having an economic ripple effect on the business of Indian citizens. To mitigate its impact, in the last tranche of economic reforms, the Central Government made numerous changes upon the Insolvency and Bankruptcy Code, 2016 (“IBC”), and its adjudicatory processes, which will have wide-ranging ramifications. In exercise of its powers under Section 4 of the IBC, the Central Government has raised the threshold for invoking insolvency to Rs 1 crore from the existing Rs 1 lakh. This provision will relegate MSMEs to civil remedies for debt recovery and may have an effect of excluding it under the IBC. At this cost, the amendment may have successfully addressed the issue of frivolous recovery claims initiated under the grab of insolvency processes due to the seemingly low original threshold of rupees one lakh.

The government has come up with IBC 2020 to streamline the CIRP, protect last-mile funding, and boost investment in financially distressed sectors. The changes put a threshold condition for initiating CIRP by the financial creditors, who are allottees under a real estate project. It also imports safeguards for successful bidders, the corporate debtors, and its assets from the offenses of the former promoters or management.

India took decades to implement such an effective insolvency regime and improve its global ranking of doing business. It promotes entrepreneurship and tries to balance the interest of the various stakeholders.

CONCLUSION

Resolving insolvency in a strict time bound manner is an important challenge for any country to maintain a healthy and robust economic system. This study has made an attempt to understand and analyze the impact of the IBC on the credit sector of the economy. The study emphasizes the fact that IBC is a big step in the direction of resolving the issues of Non-Performing Assets and hence will act to the rescue of banks which have been facing a lot of difficulties due to corporate defaults. The number of companies that have benefitted from this law is large, there has been improvement in the speed as well as the success rate of the resolution process.

There is still a long way to go ahead and as the saying goes,

“We have to acknowledge the progress we made, but understand that we still have a long way to go. That things are better, but still not good enough.”

Suspension Of Insolvency And Bankruptcy Code (IBC)

An ordinance was recently approved to amend the IBC in order to provide relief for the businesses and corporates after the pandemic and subsequent lockdown significantly impacted most of their economic activities.

Section 10A was introduced in the Code which suspended the following sections 7, 9 and 10 of the provision. Section 7 provided for initiation of insolvency proceedings by financial creditors, Section 9 provided the same creditors and Section 10 for a corporate applicant.  The introducing provision suspended filing for initiation of corporate insolvency resolution process of a corporate debtor for any default for a period of six months extendable up to a year.

The Economic stress because of the ongoing pandemic COVID-19 led to the various losses in the different sectors. The Industries are grappling with continuous supply chain breakdown, trouble handling the slowdown in demand, face unavailability of labour and ultimately, finding themselves in positions with inabilities to complete the contracts. Moreover, the service sectors such as aviation or hospitality are also facing reluctance of the customers because of the precautionary lockdown. The entire by-product increased stress and number of debt-laden Indian corporates.

There is also a concern over the value money as currently under IBC there are around 220 unresolved cases which means that only 44 per cent amount of the total debt has been recovered yet since the commencement of this mentioned law in 2016. Moreover, for every one case which is left resolved there are four cases which would end up in liquidation, hence a situation where the recovery falls down to 15-25% sharply. Specifically guiding that the creditors would have to undergo large cuts on their loans.

The litigation pressure on judiciary has also then increased since the judicial system, already as burdened as such, would have to handle a huge influx of cases after the suspension of IBC.

In addition to that there is also a ballooning of liabilities without resolution. When a corporate applicant or creditors themselves cannot initiate the insolvency proceedings, it consequently restrict the exiting of a business and also lock-up its following assets. Therefore, only further deteriorating their position in terms of value and only leading to losses.

The suspension of this specific law will also negate the two states objectives. The objective of faster resolutions and the objective of value maximization under IBC.  The creditors will thus be forced to turn to older mechanisms to help them address defaults. This diversion from the Code to other methods may alternatively result in innumerable recovery cases. Along with it there can also be a flow of various security enforcement cases being filed, thereby only further burdening the courts.

The decision also the potential to hamper the economy in the long run if there is any absence of definite and timely resolution. In a case where the NPAs of banking sector may rise and increment their lending rates. Hence, hampering the investment and of course credit cycle, most probably lowering investor the confidence.

As the introducing provision required the proceedings under IBC to never be able file for default occurring in the suspension period, so:

  1.  The Promoters of the companies that may have the capacity to repay dues could intentionally force a default during this period and get safe from never to be held accountable under the IBC.
  2. While only the pandemic-related cases should get the benefit of this absolution, it will particularly be very much tough to pinpoint why only a pandemic serves as the reason for the non-servicing of loans.
  3. Furthermore, it can adversely affect operational creditors, such as the suppliers and the vendors. They would not be able to file insolvency proceedings which may go on to lead to artificial delays in payments done by corporate debtors on them.  

Also there has been no suspension against personal guarantors of a company. That is, the directors or promoters of any company who have provided personal guarantees to its lenders, might still find a position in the insolvency court under IBC. The ordinance in addition to that, does not grant any relief to applicants whose resolution plans got approved of late.

The ability to implement the said plans will be undoubtedly be directly impacted by such interruptions going forward.

RDDBI, SARFAESI AND IBC

RDDBI 1993

Banks and financial institutions have been experiencing considerable difficulties in recovering loans and enforcement of securities charge with them. The procedure for recovery of debts due to the banks and financial institutions, which is being followed, has resulted in a significant portion of the funds being blocked.

The Committee on the Financial System has considered the setting up of the Special Tribunals with special powers for adjudication of such matters and speedy recovery as critical to the successful implementation of the financial sector reforms. An urgent need was, therefore, felt to work out a suitable mechanism through which the dues, to the banks and financial institutions could be realised. In 1981 a committee had examined the legal and other difficulties, faced by banks and financial institutions and suggested remedial measures including changes in law. This committee also suggested setting up of Special Tribunals for recovery of dues of the banks and financial institutions by following a summary procedure. Keeping in view the recommendations of the above Committees, the Recovery of Debts due to Bank and Financial Institutions Bill, 1993 was introduced in the Parliament.

THE RECOVERY OF DEBTS DUE TO BANKS AND FINANCIAL INSTITUTIONS ACT, 1993

An Act to provide for the establishment of Tribunals for expeditious adjudication and recovery of debts due to banks and financial institutions and for matters connected therewith or incidental thereto.

After a decade or working of the (RDDBI ACT) it was felt that RDDBI act was unable to achieve the desired result of efficiently recovering money from the borrower’s. This led to the enactment of the Securitization and reconstruction of final assets and enforcement of security interest act 2002.

SARFAESI 2002

The SARFAESI Act was passed on December 17, 2002, in order to lay down processes to help Indian lenders recover their dues quickly. The SARFAESI Act essentially empowers banks and other financial institutions to directly auction residential or commercial properties that have been pledged with them to recover loans from borrowers. Before this Act took effect, financial institutions had to take recourse to civil suits in the courts to recover their dues, which is a lengthy and time-consuming process.

As per the SARFAESI Act, if a borrower defaults on a loan financed by a bank against collateral, then the bank gets sweeping powers to recover its dues from the borrower. After giving a notice period of 60 days, the lender can take possession of the pledged assets of the borrower, take over the management of such assets, appoint any person to manage them or ask debtors of the borrower to pay their dues too, with respect to the asset. This recovery procedure saves banks and financial institutions a lot of time which otherwise would be long drawn out due to the intervention of courts.

With an attempt to revamp the slow pace of recovery of defaulting loans and mounting levels or non performing assets of banks and financial institutions. The SARFAESI act provides the secured creditor the right to enforce the security without the intervention of either court or tribunal by following procedure prescribed under section 13 of SARFEASI act. Thereafter the constitutional validity of SARFAESI act was challenged in Mardia chemicals Ltd V Union of India.

In the landmark judgement delivered in Mardia chemicals V Union of India the hon’ble supreme court held that provision of the securitization and reconstruction of financial assets and enforcement of security interest act 2002, SARFAESI ACT 2002, are valid except section 17 (2). Which is ultra vires of article 14 of the constitution of India.

It’s a new weapon to strengthen the hands of co-operative banks, but a small one still.

IBC 2016

The Insolvency and Bankruptcy Code 2016 offers a uniform comprehensive insolvency legislation to Corporations, Firms and Individuals (other than financial firms).

One of the fundamental features of the Code is that it allows creditors to assess the viability of a debtor as a business decision, and agree upon a plan for its revival or a speedy liquidation.

The IBC creates a new institutional framework, consisting of a regulator, insolvency professionals, information utilities and adjudicatory mechanisms, that will facilitate a formal and time bound insolvency resolution process and liquidation.

Insolvency and Bankruptcy code is a sound legal framework of bankruptcy law is required for achieving the following objectives:-

Improved handling of conflicts between creditors and the debtor It can provide procedural certainty about the process of negotiation, in such a way as to reduce problems of common property and reduce information asymmetry for all economic participants.

To consolidate and amend the laws relating to re-organization and insolvency resolution of corporate persons, partnership firms, and individuals. To fix time periods for execution of the law in a time-bound settlement of insolvency (i.e. 180 days).To maximize the value of assets of interested persons.

To establish higher levels of debt financing across a wide variety of debt instruments. To deal with cross-border insolvency .To resolve India’s bad debt problem by creating a database of defaulter list.

In short we can say that SARFAESI is upgraded version of RDDBI, and IBC is upgraded version of SARFAESI.