IBC and its Impact on The Banking Sector

Introduction:

The Insolvency and Bankruptcy Code of 2016 (Code/IBC) is one of India’s ground-breaking economic reforms. It aims to address the financial crisis in enterprises within specified time frames while balancing the interests of all stakeholders and maximizing the value of the distressed company’s assets. It’s a rare example of a law that was quickly enacted and implemented. The IBC is legislation that was created by, for, and by the people. The Code has shown to be an effective economic tool in reviving business enterprises that were about to be liquidated. It has resulted in a full policy turnaround, shifting from recovery to revival. Liquidation is only used after all other options for resurrection have failed.

What is the 2016 Insolvency and Bankruptcy Code (IBC)?

Parliament passed the Insolvency and Bankruptcy Code in 2016. In May of 2016, the President signed it into law. The policy was adopted in reaction to banks’ enormous accumulation of non-performing loans and debt settlement delays. In India, insolvency resolution takes an average of 4.3 years, compared to one year in the United Kingdom and 1.5 years in the United States of America. This time, as well as the settlement of large-ticket loan accounts, is intended to be reduced.^[1]

What is the IBC’s goal?

The IBC applies to all types of businesses, including corporations, partnerships, and individuals. It creates a timetable for resolving insolvency. When a debtor fails to make a payment, creditors seize the debtor’s assets and are compelled to make judgments on how to settle the bankruptcy. Under the IBC, both the debtor and the creditor can initiate ‘recovery’ processes against each other.

What is the Code’s deadline for completing the exercise?

Companies must complete the whole insolvency procedure within 180 days under the IBC. If the creditors do not object to the extension, the deadline may be extended. The whole bankruptcy process must be finished in 90 days for smaller enterprises, including start-ups with annual sales of Rs 1 crore, and the deadline can be extended by 45 days. If the debt is not resolved, the firm will be liquidated.

Who is in charge of the IBC proceedings?

The Insolvency and Bankruptcy Board of India has been established as a regulator to oversee these proceedings. The IBBI has 10 members, including officials from the Finance and Law Ministries, as well as the Reserve Bank of India.

Who aids the settlement of insolvency?

A qualified expert oversees the settlement process, manages the debtor’s assets, and provides creditors with information to help them make decisions.

Who decides on the proceedings?

The resolution process will be arbitrated by the National Businesses Law Tribunal (NCLT) for corporations and the Debt Recovery Tribunal (DRT) for individuals. The courts provide their approval to begin the resolution process, appoint an insolvency practitioner, and approve the creditors’ final judgment. The Insolvency and Bankruptcy Board regulates insolvency practitioners, insolvency professional agencies, and information utilities created under the Code.

What is the Code’s method for resolving insolvency?

When a default occurs, the debtor or creditor may commence the settlement procedure. The procedure is overseen by an insolvency professional. The professional manage the debtor’s assets and provides financial information to the creditor from the debtor’s information utilities. This method is valid for 180 days, after which any legal action against the debtor is forbidden.

What does the creditors’ committee do?

The insolvency professional appoints a committee made up of the financial creditors who lent money to the debtor. The creditors’ committee makes choices on the debt’s future. They can choose to resuscitate the debt owed to them by changing the repayment schedule or selling the debtor’s assets to recuperate their losses. The debtor’s assets are liquidated if a decision is not made within 180 days.

What occurs during a liquidation?

If the debtor enters into liquidation, the procedure is overseen by an insolvency expert. The following is the sequence in which the proceeds from the sale of the debtor’s assets are distributed: First, there are insolvency resolution charges, such as the insolvency professional’s fee; second, there are secured creditors, whose loans are secured by collateral; and third, there are dues to workers and other employees; and fourth, there are unsecured creditors.

Decoding Credit Culture^[2]

Credit culture is described as the ties that bind the credit method together and serve as the foundation for credit discipline. Credit culture may be defined as a set of principles, behaviors, deterrents, and incentives that encompass lending or credit choices, such as institutional priorities, traditions, and ideologies. The totality of a lending institution’s credit ideals, attitudes, and actions is referred to as credit culture. It’s about what’s done and how it’s done. The credit culture of a bank has a significant impact on lending and credit risk management.

The credit culture of a bank is a unique blend of rules, procedures, experience, and management attitude that defines the lending environment and sets the bank’s accepted lending behavior. Credit culture, in general, is a sophisticated network of ideas, behavior, philosophy, thinking, style, and expression connected to the credit function’s administration. A bank’s lending and credit risk management systems and processes are heavily influenced by its credit culture. The ultimate goal of a credit culture is to create a risk management environment that promotes good banking.

A market thrives for freedom in the course of its business at three critical stages: starting a business (free entrance), continuing the business (free competition), and ending the business (free exit) (free exit). In a market economy, it is only natural for certain company plans to fail for various reasons, and this may lead to a scenario of default, which has a significant influence on the country’s macroeconomic aspect, and which must be managed in a timely and expedient manner. It’s perplexing that an economy that promotes open entry and free competition lacks the necessary mechanisms for unproductive enterprises to quit freely.

As a result, the IBC was enacted to save the day by removing unproductive enterprises from the system in a timely way, thereby building a pillar to contribute to the economy’s strength.

Lending institutions have re-examined the policies and practices that govern their risk management after the Global Financial Crisis. These companies’ leaders have taken advantage of the chance to establish or re-establish their risk culture and improve their awareness of credit risk. The goal of credit culture is to build the proper risk basis for effective banking. A credit culture’s role is to build a risk-management environment that fosters…good banking. Given the complexity and breadth of the banking industry, it is reasonable to conclude that credit culture is critical in lending institutions.

IBC and Credit culture^[3]

The code’s implementation has aided in enforcing discipline in the country’s credit culture. Defaults are discouraged in the IBC credit culture. There has also been a shift in corporate culture: corporations now recognize that when things go wrong, they will not automatically receive a bailout from government dollars. The goal of the IBC was to establish conditions that would allow credit to be created on the domestic market and investments to be taken from the global market. It was required to build a culture of deterrence against default to attain those goals. The habit of taking lenders to court to postpone debt repayments is progressively dying away. The Insolvency and Bankruptcy Code of India ensures that creditors are paid on time, making India a more appealing investment location.

How can IBC benefit Banks?^[4]

The new legislation aims to unify the current framework by establishing a unified bankruptcy and insolvency law. The growing number of non-performing assets (NPAs) in the banking industry and other financial institutions has stifled lending in India, particularly among public sector banks. As a result, the Bankruptcy Code was enacted to help the Indian economy overcome its worst-case scenario. The newly enacted Code envisions a formal insolvency resolution procedure (IRP) for enterprises, either by devising a sustainable survival mechanism or ensuring a quick liquidation. As a result, the revised Code may significantly reduce the amount of long-pending cases while also ensuring that NPA issues are resolved more quickly by various banks.

High Courts, Company Law Boards, Board for Industrial and Financial Reconstruction (BIFR), and Debt Recovery Tribunal (DRT) are now four separate judicial venues with overlapping jurisdictions, resulting in delays and complications in the recovery of bad debts. In this context, bankruptcy law’s insolvency resolution procedure aims to unify the current framework by enacting single legislation that ensures the timely resolution of insolvency.

The Bankruptcy Code (IBC) will provide more assistance to Indian lenders, including secured and unsecured creditors. During liquidation, the Code establishes a priority order for allocating assets/proceeds. The following is the sequence in which the assets will be divided.

1. Secured creditors^[5] will be paid the whole amount owed, not just up to the value of their security,
2. unsecured creditors will be paid first, followed by trade creditors, and
3. government dues will be paid after unsecured creditors.

The Adjudicating Authority must impose a moratorium on all outstanding processes by order for 180 days from the date of admission of the application to commence insolvency resolution procedures, according to Section 14 of the law. Except for the liquidation process, the stay on outstanding cases prohibits the execution of judgments and decrees, as well as the transferring, encumbering, alienating, or disposing of corporate debtor’s assets. The legislation, however, does not apply to transactions that the Central Government may notify in collaboration with any financial sector regulator. This clause of the legislation also excludes the delivery of necessary products or services to the corporate debtor that is not to be terminated, suspended, or interrupted during the moratorium period.

• Adjudication of insolvency resolution: The National Company Law Tribunal (NCLT) will be the adjudicating authority for insolvency resolution for limited firms and limited liability partnerships (LLPs). Individuals and unincorporated entities will have their insolvency cases heard by the Debt Recovery Tribunal (DRT). Licensed insolvency professionals (IPs) who are members of insolvency professional agencies will undertake the resolution proceedings (IPAs). Performance bonds equal to the assets of a firm under bankruptcy resolution will also be provided by IPAs.
• Liquidation: During liquidation, the law prohibits the sale of a defaulter’s property to those who are unqualified to be a resolution applicant.
• Penalties: The Bill has a clause that states that anyone who violates any IBC requirement for which no punishment has been stated shall be fined between Rs. 1 lakh and Rs. 2 crores.
• Information utilities (IUs): To aid bankruptcy resolution, information utilities (IUs) will be formed to gather, collate, and transmit financial data.
• Insolvency and Bankruptcy Board of India: The functioning of IPs, IPAs, and IUs will be regulated by the Insolvency and Bankruptcy Board of India, which will be established soon.
• Insolvency and Bankruptcy Fund: The Insolvency and Bankruptcy Fund is established by the Code. However, the cash’s intended use has yet to be determined.

Resolved solely on a Commercial Basis

Both creditors and debtors can commence procedures under the code. The fact that the business part of insolvency resolution is separated from the judicial side, and that the role of the adjudicating body is limited to facilitating due process rather than adjudicating on the merits of the resolution, is a distinguishing feature of the IBC.

Inclusion of the NBFIs in the IBC is Credit Positive

Because the IBC regulation provides for the orderly resolution of a stressed firm, the inclusion of NBFIs [non-banking financing institutions] under the country’s bankruptcy legislation is credit positive for India’s banks, which are NBFIs’ major lenders. Until now, the only way for NBFIs to be resolved was through liquidation.

Conclusion

Before the IBC, a lack of an efficient resolution structure prevented lenders from providing money because they were doubtful of their capacity to collect the debt, resulting in a reduction in finance availability and, as a result, fewer viable projects. It was necessary to end the culture of not repaying debts and getting away with them. The borrower would have little incentive to repay if IBC did not exist. In the financial year 2018-19, banks collected 42.5 percent of the amount submitted under the IBC, compared to 14.5 percent through the Sarfaesi resolution process, 3.5 percent through Debt Recovery Tribunals, and 5.3 percent through Lok Adalats. The recovery under the IBC was Rs 70,819 crore against claims of Rs 1.66 lakh crore.^[6]

It’s important to remember that changes in credit culture take time, they don’t happen suddenly. When attempting to alter a culture, individuals who benefited from the previous culture will want to protect the status quo. The ultimate message is that India’s credit culture is evolving in a positive direction. This might be extremely beneficial in recruiting new investments from corporations searching for alternatives to China.

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References:

[1] Insolvency and bankruptcy code News – Latest insolvency and bankruptcy code News, Information & Updates – BFSI News -ET BFSI ETBFSI.com, https://bfsi.economictimes.indiatimes.com/tag/insolvency+and+bankruptcy+code

[2] “Bankruptcy law has changed the credit culture in banks” mint, https://www.livemint.com/industry/banking/-bankruptcy-law-has-changed-the-credit-culture-in-banks-11600394316865.html

[3] Insolvency & Bankruptcy Code – Changing India’s Credit Culture | lawstreetindia.com Lawstreetindia.com, http://www.lawstreetindia.com/experts/column?sid=486

[4] Saloni Shukla, Banks can take advantage of the IBC to clean up their balance sheets: RBI, The Economic Times, https://economictimes.indiatimes.com/news/economy/policy/banks-can-take-advantage-of-the-ibc-to-clean-up-their-balance-sheets-rbi/articleshow/62206604.cms?from=mdr

[5] The secured creditors are the creditors who have a security interest on the assets of the borrower. security interest means right, title or interest or a claim to the property, created in favour of, or provided for a secured creditor by a transaction which secures payment or performance of an obligation and includes mortgage, charge, hypothecation, assignment, and encumbrance or any other agreement or arrangement securing payment or performance of any obligation of any person

[6] Insolvency & Bankruptcy Code – Changing India’s Credit Culture | lawstreetindia.com Lawstreetindia.com, http://www.lawstreetindia.com/experts/column?sid=486