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India plugs a loophole that let people game the bankruptcy code

Reuters/Shailesh Andrade
Good move.
By Nupur Anand
Published Last updated This article is more than 2 years old.

India’s driven another nail into the coffin of habitual loan defaulters.

Wilful defaulters, promoters of loan accounts under stress for a year, those habitually non-compliant with repayment schedules, and promoters of firms going under the hammer won’t get to bid anymore for assets being liquidated under the Insolvency and Bankruptcy Code (IBC).

On Nov. 23, president Ram Nath Kovind cleared the Narendra Modi government’s ordinance amending the IBC. 

“The ordinance aims at putting in place safeguards to prevent unscrupulous, undesirable persons from misusing or vitiating the provisions of the code,” said the notification by the ministry of corporate affairs.

The IBC came into effect in December 2016 as a key step towards the resolution of the toxic loan mess. Indian lenders had Rs7.29 lakh crore of gross non-performing assets (NPAs) at the end of March 2017, equivalent to about 5% of the country’s GDP.

However, IBC has had teething trouble which this ordinance seeks to address at least partially. 

Analysts, meanwhile, expect more amendments in future. “As the cases are being referred to the bankruptcy courts and they are going through the proceedings, more such questions will crop up and therefore we will see more changes as we move ahead,” said Ashvin Parekh who runs Ashvin Parekh Advisory Services.

The new reforms

Earlier this month, the government had constituted a 14-member panel to review the IBC, especially the problem areas impeding efficiency of the resolution process. 

The Modi cabinet cleared the amendments on Nov. 22. With the president having signed it now, the ordinance will be tabled in parliament during the winter session expected to begin on Dec. 15

These measures are likely to ensure that banks, already unable to recover their dues, don’t get short-changed even in the resolution process.

“In order to retain control over their companies, the promoters would have had bid aggressively during the proceedings,” said Anil Gupta, vice-president (financial sector) at rating agency ICRA. “However, it’s possible that after gaining control again, they would have ended up on the verge to bankruptcy again two-three years down the line. Therefore, this step is extremely important to improve credit culture.”

On the other hand, it’s believed that corporates had protested against these changes. Citing changing business cycles as a reason for defaulting, they had wanted to participate in the bids if their financial positions allowed.

It’s also possible that banks may lose out more now during liquidation. “Unlike existing promoters, parties interested in the business (during the liquidation) will bid more conservatively. As a result, banks will stand to gain lesser as recovery amount. However, short-term pain is better than long-term problems,” added Gupta.

So, in the near term, this may not augur well for banks for whom the recovery situation looks grim anyway. For out of the Rs4 lakh crore owed by the top-50 defaulters, banks are likely to retrieve only Rs1.6lakh crore—about 40%—as per a CRISIL report released in July.

“We don’t mind haircut, but we don’t want to be bald,” Rajnish Kumar, chairman of the country’s largest lender, State Bank of India, had said at a press conference on Nov. 23 in Mumbai.

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