Strengthening IBC framework, really?

While putting on hold its plans to implement the so-called “fresh-start process” for indebted poor people under the Insolvency and Bankruptcy Code (IBC), the government wants to first focus on bolstering the IBC architecture to yield quick resolution of toxic assets.

The reference here is to the delay in completion of the corporate insolvency resolution process (CIRP) as well as the low amount realised by creditors from their non-performing assets (NPAs) — a fancy nomenclature for bad loans. Let us capture a few basics.

Faced with ballooning NPAs, the Modi government enacted the IBC in 2016. This legislation overrides all other subsisting laws and gives a strong handle to banks for resolving NPAs within a strict time frame. In 2017, it amended the Banking Regulation Act, giving the Reserve Bank of India (RBI) powers to force banks to act if they don’t on their own.

On February 12, 2018, the RBI issued a circular that provided a foundational basis for resolving NPAs. As per this circular, for accounts with aggregate exposure greater than Rs 2,000 crore, as soon as there was a default in the account with any lender, all lenders — singly or jointly — shall initiate steps to cure the default by preparing and implementing a resolution plan. This needed to be done within 180 days from the date of default.

In case the lenders fail to meet this deadline, they are required to refer the account to the National Company Law Tribunal (NCLT) which would initiate proceedings under IBC. The NCLT would get 180 days to complete the resolution process. A further 90 days is allowed in exceptional circumstances. Thus, the outer limit for consummating the process is 270 days.

The raison d’être behind imposing this timeline and involving the RBI to shepherd the exercise was to sell the NPA-afflicted entity as a going concern in an ‘objective’ and ‘transparent’ manner and maximise the realisation from sale.

But we are far from achieving the intended result. Out of 1,723 firms that were undergoing resolution until December 2021, around 73% had exceeded the 270-day limit, resulting in an erosion of stressed asset value. Recovery by financial creditors crashed to a record quarterly low of 13.4% of the admitted claims during October-December 2021. Furthermore, in 363 major cases, banks have taken a haircut of 80% on an average.

Meanwhile, the NPAs’ position has not shown any significant improvement. According to a statement by Minister of State for Finance Bhagwat K Karad in Parliament, the NPAs of banks declined from Rs 10,36,000 crore as on March 31, 2018 to Rs 8,34,000 crore on March 31, 2021. This excludes the Covid period — March 1, 2020 to March 24, 2021 — when banks were not allowed to recognise NPAs. On their inclusion, we may not see any improvement.

What explains the delays, the woefully low yield from the resolution process and continuing high non-performing assets?

This has a lot to do with a revised RBI circular dated June 7, 2019 — issued in supersession of the February 12, 2018 order — under directions of the Supreme Court. It gives banks 180 days to come up with a resolution plan (in addition to 30 days to enter into an inter-lender agreement). If they don’t, they are required to make an additional provision of 20%. If they don’t finalise the plan within 365 days, an additional 15% provision has to be made.

Unlike the February 12, 2018 order which mandates the bank to refer the account to National Company Law Tribunal at the end of 180 days, there is no such compulsion under the revised circular. Even if the resolution plan is not ready within 365 days, all that it requires the bank is to make an additional provision of 35% (20% for the first 180 days plus 15% for up to 365 days). With this, the bank will sit pretty complacent.

The bank has no incentive to take it to NCLT, see it from another angle. If the resolution plan is not implemented within one year from the default date, the bank has to make a provision of 50% — 15% normal ageing provision and 35% additional.

At the end of 15 months, with the normal ageing provision increasing to 40% plus 35% additional provision, the total provisioning requirement will be a steep 75%.

Having adjusted a major chunk, i.e. 75% of the loan amount in the profit & loss account, where is the incentive for the bank to recover the money by initiating proceedings under IBC?

In short, by taking away powers from the Reserve Bank of India to navigate the NPA account for resolution under IBC, giving too much of leeway to banks in preparing the resolution plan and removing the compulsion on them to make reference to NCLT, the June 7, 2019 circular has rendered the IBC process dysfunctional. Against this backdrop, any talk of strengthening the Insolvency and Bankruptcy Code framework looks like a joke.

(The writer is a policy analyst.)