Preserve the IBC

Suspension should not result in unintended consequences

The Union Cabinet has cleared the proposal to suspend the Insolvency and Bankruptcy Code (IBC) for six months, and it can be extended up to a year. The changes are likely to be implemented through an Ordinance. The purpose behind suspending the IBC is not very difficult to understand. Companies are facing significant disruption on account of the nationwide lockdown and other measures taken by the government to contain the spread of Covid-19. The government is also working on a special resolution framework for micro, small, and medium enterprises, while the threshold for triggering the insolvency process has been increased substantially. The Reserve Bank of India (RBI) has also allowed a moratorium on all term loan instalments till August-end.

 

While all such measures are designed to extend relief to businesses in these extraordinary times, policy-makers would do well to account for the unintended consequences as well. For instance, banks are worried that the moratorium on repayment of loans could affect the credit culture and lead to higher non-performing assets (NPAs). In the context of the IBC, it is important that the government involve the RBI and large banks to decide on the ground rules with utmost care and clarity. For instance, if the cutoff date is March 1, what would happen to companies that might have defaulted before that? Also, how does one differentiate borrowers hurt by Covid from those impacted by other factors? A sharp correction in economic indicators suggests that businesses started facing difficulties much before the lockdown was announced.

 

Further, what will happen to firms that had defaulted and lenders were preparing to start the proceedings under the IBC. The resolution of such accounts will help unlock funds, which can be used by banks for further lending. Although resolution might become a bit difficult because of economic uncertainty, it cannot be a reason for suspension. Potential bidders may want to preserve cash at this stage instead of buying assets put on the block. A blanket suspension would not work as firms facing difficulties may themselves want to file for bankruptcy resolution. It is widely expected that the RBI would allow a one-time restructuring of debt as a large number of firms may not be in a position to service loans even after the moratorium period. Most economists expect the Indian economy to shrink in the current financial year. Lower sales and operating profits will make debt servicing difficult. Therefore, the government will need to work with the banking regulator in framing the suspension mechanism.

 

It is vital to note that the health of the banking system is no less important. While the NPAs are likely to rise in general because of economic disruption, policy-makers must make sure that the banking system is not put under excessive pressure, which could threaten financial stability and affect economic recovery. The government must also ensure that the suspension of the IBC doesn’t end up affecting its efficacy in the medium term. The implementation of the IBC is one of the biggest reforms in recent years and must be preserved. Even as the economy returns to normalcy, the IBC framework would be required to reallocate capital from weaker firms, which would not be able to survive the economic shock, to more productive ones. A delay in this process would affect the pace of recovery.