Integrity of insolvency processes: A tough ask

Source: This post is based on the article “Integrity of insolvency processes: A tough ask” published in Live Mint on 2^nd September 2021.

Syllabus: GS3- Indian Economy and issues relating to Planning, Mobilization of Resources, Growth, Development and Employment

Relevance:  Role of Insolvency bankruptcy code in maintaining the health of financial institutions.

Synopsis: Issues hampering the effective implementation of IBC and suggested reforms.

Background

There is wide apprehension that the IBC might become a failed attempt to comprehensively tackle corporate sickness or resolve the NPA’s in the banking sector.

What are the issues hampering the effective implementation of IBC?

• Huge delays in special courts.
• Lack of court capacity.
• Dubious decisions by resolution professionals.
• Asymmetrical information on the state of assets shared with different parties.
• Defaulters trying to control the system for favourable resolutions and steep haircuts.

What reforms are needed?

PSBs need to improve their credit appraisal and asset valuation skills: The entire IBC process seems designed primarily to help banks, mainly state-owned, recover their dues. This is a well-intended design because loan recovery lets banks extend fresh credit that gives economic growth an impetus. Yet, designing a large part of the IBC process for this alone has created structural flaws. Because many public sector banks (PSBs) have carried over their flawed credit appraisal practices to the Committee of Creditors (CoCs) that take charge of insolvent firms for resolution, which tends to impair outcomes.

The issue of frequent legislative amendments and rule changes needs to be addressed: The role of unstable government is another issue impacting the resolution process. For instance, sectors such as power, road, telecom and mining projects took on debt on the basis of government policy. But when the state went back on a commitment or changed a policy overnight or failed to pay upon project completion, these sectors were rendered incompetent.

Diversion of Funds needs to be regulated: Many Indian industrial houses have over-borrowed relative to project costs and diverted those proceeds to either finance their own equity contribution or fund something else. With the economic slowdown, many of these projects were unable to generate adequate cash flows to service these irrational debts.

Way forward

While reducing concentrations of authority, as the IBBI proposes, could help in several ways, there’s a lot more that ails our system. As a regulator, the IBBI may need to intensify its coordination with other regulators to strengthen its processes else the IBBI is unlikely to solve some of these deep-seated problems.