Poor run for IBC continues. What ails it?

The Insolvency and Bankruptcy Code (IBC) of 2016 continues to yield abysmally low debt recoveries, even though the latest cumulative data until FY23 shows a minor uptick.

The IBC of 2016 was billed a game changer and economist Arvind Panagariya called it one of the “big-ticket economic reforms”. But it has turned out to be far worse than its predecessor which was junked in 2016 – The Sick Industrial Companies Act (SICA) of 1985 and its Board for Industrial and Financial Reconstruction (BIFR) and Appellate Authority for Industrial and Financial Reconstruction (AAIFR). With the total recovery of debt at 17.6% of the “admitted claims” by the end of FY23 (cumulative) – up from 16.6% by the end of FY22 – and 75% of the firms ending up in scrap sale, it has grossly underperformed in comparison to its predecessor (which had a recovery rate of 25%).

Here is what the detailed data released up to FY23 by its regulator Insolvency and Bankruptcy Board of India (IBBI) shows.

Reviving business, recovering debt or a blackhole?

The IBC came into force in 2016 but the IBBI began providing full data on debt recovery from the ‘resolution’ and ‘liquidation’ processes only from FY20 – although partial information is available since FY18. By the end of FY20 (cumulative or inclusive of all the previous recoveries taken together), the debt recovery from both the processes stood at 23.2% of the “admitted claims” – lower than 25% under the SICA.

Progressively, the recovery fell to 19.8% by FY21 and 16.6% by FY22 but there is an uptick to 17.6% by FY23. This means, banks (mostly public banks) and other financial creditors have lost 82.4% of their credits/loans (“haircut”) through the IBC by the end of FY23.

In some cases, the debt has been so high (90-95%) that a parliamentary panel way back in 2021[1] expressed serious concerns and asked the government to take several steps, including fixing a benchmark for the quantum of haircut. It said the “fundamental aim of this statute (IBC) is to secure creditor rights” and a “greater clarity of purpose” was needed “particularly considering the disproportionately large and unsustainable “hair-cuts” taken by the financial creditors over the years”.

In addition to low recovery, there are other concerns.

(a) Recovery through ‘resolution’ (in which bankrupt firms are taken over and revived) has steadily fallen from 46% by FY20 to 31.8% by FY23 (cumulative). That is, a net loss of 68% of the capital. With time, the efficiency should have improved as familiarity and expertise improve – unlocking more capital and unleashing entrepreneurial spirits. Both are getting hurt.

(b) Recovery through ‘liquidation’ (in which firms are sold off as scrap because there are no takers or can’t be revived), is abysmally low – 4.8% by FY20 and 5.6% by FY23 (which caused the minor uptick at the end of FY23). This is a triple whammy: loss of credit, business is shut down and sold as scrap and loss of jobs due to the shutdowns. As a World Bank report of 2020 had said, amidst the pandemic when fear of shutdown was high), high liquidation is a sign of “inefficient insolvency systems” and “absence of a rescue culture”.

Source: IBBI newsletters

(c) IBC’s primary goal is to rescue and revive firms facing financial stress for various reasons (liquidity crunch, business failure, administrative delay, uneven playing field or any other) and protect the creditors. This is defeated because 75% of the firms undergoing the IBC proceedings have ended up with ‘liquidation’ – the rest 25% in ‘resolution’ (revived or rescued). The high proportion of liquidation is self-defeating. Besides, debt recovery from liquidation is a mere 4.7-5.6% – that is, 94% of money ploughed into 75% firms undergoing the IBC have been lost permanently. Imagine the magnitude of loss to the economy – money for bankers, business setup for entrepreneurs, plant and machinery and jobs etc.

(d) Time is of essence in bankruptcy proceedings. The average time for IBC ‘resolution’ has been going up from 415 days by FY20 to 831 days by FY23 (cumulative). Excluding the time taken by the NCLT (legal resolution), the average time for ‘resolution’ are 375 days and 682 days, respectively. This is against the mandated 270 days – which had to be extended to 330 days in 2019. Every day’s delay progressively devalues assets under bankruptcy and makes recovery more difficult. It is this long delay that explains why the IBC outcomes were first recorded in full only by FY20, although the law came into force in 2016.

(e) During the IBC processes, asset stripping is not allowed (“avoidance transactions”) and supposed to be restored as fast as possible to ensure the firms don’t lose their intrinsic value. By FY22, such transactions were 777, amounting to ₹2.2 lakh crore of which only 48.4 crore or 0.02% had been “clawed back”. By FY23, the number went up to 871, the amount went up to ₹2.85 lakh crore and what was “clawed back” also went up but to mere 1.8%.

What ails IBC?

There are several reasons why the IBC fails to perform to the expectations – other than evasive arguments like a new experiment takes time to deliver. The most important one is political will. By 2018, the government had started diluting it.

This was first revealed by former RBI Governor Urjit Patel, who had suddenly resigned in 2018. In his 2020 book “Overdraft: Saving the Indian Saver” he severely criticised the government for diluting the IBC and the powers of the RBI to regulate stressed assets – after the RBI issued a “revised framework” in 2018 asking banks to start resolution process after a day’s default. He pointed out that this was despite the Supreme Court’s 2019 verdict not finding the RBI’s framework problematic. The same year, then Deputy Governor of RBI Viral Acharya also wrote a book “Quest for Restoring Financial Stability in India”[6], pointing fingers at the government for diluting the IBC (“…forbearance in loss recognition crept in again for some asset classes; and the resolution of several non-performing borrowers under the Insolvency and Bankruptcy Code was stayed”).

The worsening outcomes over the years is reflection of this political back-paddling.

When questioned about the shockingly high haircuts in some cases (90-95%), the government passed the responsibility saying that if a Committee of Creditors (COC) didn’t agree for high haircut it wouldn’t have gone to the NCLT (adjudicator) in the first place and that COC’s wisdom was “supreme” in its reckoning. The panel proposed a code of conduct for the COC and a benchmark for the haircut. Three years down the line, there are no signs of either.

Then there are other problems with the IBC.

An investigating report flagged how all stressed assets are treated as a mere banking problem and ploughed into the IBC as one-stop solution. This leads to many projects (even completed ones) getting scrapped due to lack of buyers and sold at throw away prices. Often, the bidders are few – as reflected in the fact that 75% firms get liquidated and overall debt recovery is 17.6%. At the same time, the government plays favourite and selectively bails out a chosen few. In 2018, when more than two dozen thermal power plants were facing bankruptcy due to problems like unviability of coal (due to cancellation of coal block allocations, rising prices of imported coal, delay in government clearances and coal allocations and delivery of plant machinery etc., the government rescued only three Gujarat-based power plants – Adani Mundra, Tata Mundra and Essar Salaya – for which it set up a special committee which allowed raising tariff and the Gujarat government agreed even when the matter was pending before the Supreme Court.

All these factors combine to make the IBC resolution a happy hunting ground for global funds and firms, even the shadowy tax-haven entities about which the government said it has no information about vis-a-vis the Adan-Hindenburg episode, and a few influential Indian companies to pick and choose from while the vast majority gets sold as scrap.

The IBBI, on its part, periodically announces process improvements, seeks views from experts. For example, three years ago it sought public comments on a code of conduct for COC that the parliamentary panel had desired but it is stuck there. But none of its process improvements have shown up in outcomes (except for the small uptick at the end of FY23).

That is because a few tweaks in the process are not what is needed. What is needed is a serious effort to understand the failing through detailed studies and analysis.

There is a need to appreciate that resolution of stressed asset requires the entire ecosystem – of policies, regulatory mechanisms, banking norms, insulation from political interferences, level-playing field and uniformity and predictability in governance etc. – to improve. The government, banks, including the central bank (RBI) zealously protect the identity of big loan defaulters – in the name of protecting business interests. Even the identity of “willful defaulters” (capable of repaying loans but don’t pay) are protected. This approach needs to change. Transparency is the first step to accountability. Without that banks can go on writing off a large corporate loan defaults as an annual banking ritual and divert the attention away from the real culprits by calling it non-performing assets (NPAs) of banks.

In the meanwhile, imagine the damage the IBC is doing to the economy as thousands of firms end up as scraps.