Overview: IMPACT OF INSOLVENCY AND BANKRUPTCY CODE ON BANKING SECTORS
Mar. 18, 2021 • Dheerja Kalra
PROFILE OF THE AUTHOR: Amisha, a second-year law student of Law Centre-1, Faculty of Law, University of Delhi.
INTRODUCTION
The Insolvency and Bankruptcy Code (IBC) was implemented in the year 2016. Previously enacted laws like Sick Industrial Companies Act (SICA), 1985, The Recovery of Debts due to Banks and Financial Institutions Act (RDDBFI), 1993, Securitization and Reconstruction of Financial Assets and Enforcement of the Security Interest Act (SARFAESI), 2002 etc. had completely faltered at dealing with stressed assets, detecting sick companies owing to slow and cumbersome revival process and had a backward approach to bankruptcy issues. There was a dire need for introducing a new law. IBC merges several previous laws pertaining to insolvency and bankruptcy into one. Section 238 of the Code has an overriding effect on all other laws. IBC came up with fresh ideas, a wider approach and a holistic method of dealing with stressed assets. It provides a time-bound process to resolve insolvency. IBC has been considered a desirable reform and comprehensive legislation for the speedy recovery of assets.
IBC AND THE BANKS
The banking industry of any country plays a key role in the growth and stability of its economy. This becomes more important for a developing country. Indian banks were burdened with soaring Non-performing Assets (NPA’s) levels but none of the laws pertaining to insolvency and bankruptcy were competent to deal with the issue. IBC attempted to reduce the growth of NPA’s. Thus, as far as the relations of IBC with banks are concerned it has to be analysed in terms of whether IBC has been able to solve the problem of recovery of NPA’s.
NON-PERFORMING ASSETS
Non-performing assets, as per the RBI guidelines are a result of non-payment of interest or principal amount for a period of 90 days. Simply, the loan is taken by the company on its assets from the bank but when the asset is not performing because they become doubtful then, NPAs become bad loans. [1] The main reason for NPA accumulation has been the non-payment by the banks’ clients. Most of the non-performing assets in India are loans given by government banks, these banks give loan to companies without checking the viability of the project or the ability of the client to pay back. There is a deep-rooted problem of corruption among employees wherein they allow companies to get away with bad loans. Often such employees manage to escape without any liability on them for the default in repayment of the loan. [2] The data from RBI affirms that the Public Sector Banks (PSB’s) have the largest share of NPA’s in the Indian banking system. Nirav Modi scam, Rotomac bank fraud, Winsome Diamond scam are just a few of the many examples which vehemently contribute to enhancing the NPA’s on banks. [3]
POSITIVE IMPACT
The role of IBC in solving the issue of NPA is more or less aimed at the removal of delay in the bankruptcy procedure. The earlier law allowed delays to exist. The World Bank Doing Business Report, 2017 (WBDB) highlights that the higher the time for resolution, the lower the recovery rate. India takes an average of 4.3 years to resolve insolvency. [4]
Section 33(1) IBC, provides for a time-bound process for insolvency of the corporate debtor. Initially, it began within a period of 180 days in addition to a 90-day extension, if applicable. This has been amended by The Insolvency & Bankruptcy Code (Amendment) Bill, 2019. [5] Now, the liquidation period starts only after 330 days. Liquidation begins automatically if the resolution process violates this time frame of 330 days. Therefore, this will accelerate the insolvency process. The amendments will bring in timely disposal of the Corporate Insolvency Resolution Process.
Banks have had the attitude of delaying the response. They lacked coordination in the entire insolvency and bankruptcy process. Pursuant to IBC, the liquidation process starts within 330 days, no matter whether the bank decides to delay or coordinate. Liquidation leads to large value destruction of the company. An illustration to the point is that of Kingfisher Airlines where lenders were unable to sell even real estate assets. Multiple failed auctions of Mallya’s properties highlighted the problems faced by public sector banks while recovering money from defaulters. The legal process was long, cumbersome and tedious. IBC attempts to overcome this issue. [6] In the present circumstances, all the pending actions against the debtor are stayed under the Code. No new actions, judicial proceedings are allowed to be instituted during the 330-day moratorium period. During this time, the debtor is prohibited from disposing off his assets. It provides a limited time to companies and creditors to reach a decision or find an amicable solution for the deteriorating state of the company by deciding their future course of action. [7]
IBC only recovers the value that remains through the quick liquidation method, distribute it among the creditors expeditiously and in a limited time frame than what was allowed under the former laws. [8] IBC accepts the failure of a business and allows them to make a new start. Previously, one failure meant wasting 15-20 years of life in the litigation process however, that is not the case any longer. The real success of IBC is the pressure it creates on loan defaulters. IBC helps companies to make their way out of the insolvency process swiftly and also ensure quick recovery of loan for banks. An absolute win-win situation for both.
NEGATIVE IMPACT
- Rivals can purchase companies for a very small amount and in the absence of healthy competition, it can be a point of depression for the economy. [9]
- The current market value of the asset and the value given to the asset for using it as loan collateral is still huge and banks need money to cover these. [10]
- There is no guarantee that banks will have no build-up for bad loans. There might exist alternative solutions. IBC does not mention any mechanism to prevent it. [11]
- No differentiation between financially distressed firms and economically distressed firms. The assets of an economically distressed firm are more valuable if kept together as a functioning unit. Such a firm should be sustained either by restructuring it among existing claimants or by selling it to new investors. [12]
CONCLUSION
IBC was implemented in the year 2016, since then it has remained under the scrutiny of experts. It has been growing and evolving. The act has undergone several amendments to meet up with the inherent and evolving lacunas. As far as the legal perspectives are concerned, IBC has proved significant and effective. It is hoped that the implementation of the Code will be even more effective in the time to come, satisfying and feeding the legislative intent allowing banks to grow and the economy of the country to further bloom.
Disclaimer: This article is an original submission of the Author. Niti Manthan does not hold any liability arising out of this article. Kindly refer to our Terms of use or write to us in case of any concerns.
FAQs
Q1. Who regulates the IBC proceedings?
A1. Insolvency and Bankruptcy Board of India (IBBI) regulates the proceedings. IBBI has 10 members; from Finance Ministry and Law Ministry the Reserve Bank of India.
Q2. Who adjudicates over the proceedings of IBC?
A1. National Companies Law Tribunal (NCLT) for companies and the Debt Recovery Tribunal (DRT) for individuals, adjudicates over the proceedings. In case of non-satisfaction by NCLT decision, an appeal can be filed in NCLAT-National Company Law Appellate Tribunal.
REFERENCES
[1] https://iasgatewayy.com/explain-in-detail-about-npa-in-banking-sector/
[2] https://tfipost.com/2018/05/ibc-npa-non-performing-assets-01/
[3] https://www.televisory.com/blogs/-/blogs/ibc-is-the-need-of-the-hour-for-the-indian-npas-mess-
[4] https://www.doingbusiness.org/en/data/exploreeconomies/india/#resolving-insolvency
[5] The Insolvency & Bankruptcy Code (Amendment) Bill, 2019
[8] https://blog.theleapjournal.org/2016/12/how-will-ibc-2016-deal-with-existing.html
[9] A study on the impact of insolvency and bankruptcy code, 2016 on Indian commercial banks- a pre and post-event analysis <http://www.jetir.org/papers/JETIRCK06009.pdf> accessed in August 2020.
[10] Ibid.
[11] Ibid.
[12] Supra Note 8.