Insolvency and Bankruptcy Code to strengthen identification and resolution of insolvencies: Crisil

The Bill pertaining to the Insolvency and Bankruptcy Code, 2015, passed in the Lok Sabha last week and awaiting final approval from the Rajya Sabha, is a watershed reform that will structurally strengthen the identification and resolution of insolvencies in India, according to Crisil Ratings.

While lenders and asset reconstruction companies (ARCs) are the immediate beneficiaries, the code will also significantly improve India’s ‘ease of doing business’ ranking, the credit rating agency said and added that over the long term, it will enhance creditor rights, boost investor confidence and facilitate deepening of India’s corporate bond market.

The agency observed that the code enhances the right of a creditor to identify insolvency and initiate resolution proceedings through an ecosystem that will include a new regulator and information utilities. It attempts to simplify legal processes, preserve value for creditors and provide them with greater certainty of outcome.

Pawan Agrawal, Chief Analytical Officer, Crisil Ratings, in a statement, said: “We believe the code will instill far greater financial discipline among borrowers.

“It can also potentially kindle investor interest in lower-rated (below AA category) corporate bonds, which will help in deepening the market. But implementation of the code is critical and the build-out of the ecosystem will take time.”

The agency assessed that for ARCs, the new code, along with 100 per cent foreign direct investments announced in the Union Budget for the current fiscal, will boost capital flows and make them an increasingly important intermediary between lenders and borrowers.

Crisil’s analysis shows recoveries by ARCs have been low at about 36 per cent with the average resolution taking about five years. That’s in line with a World Bank study, which said it takes more than four years to wind up a sick company in India, or twice the time taken in China, with recovery at just at about 25 per cent, which is among the lowest in emerging economies. The new code prescribes a much faster timeline of 180 days for resolution.

Krishnan Sitaraman, Senior Director, Crisil Ratings, said: “Quicker resolution will allow ARCs to churn capital faster and enhance returns. It will also attract investments into the distressed assets space.”

Crisil’s analysis of recoveries indicate that smaller assets (debt up to Rs 100 crore) have a shorter resolution timeframe and better recovery rate compared with the larger ones because of the greater bargaining power of banks.

It observed that the current asset quality challenges at banks stem from disproportionate exposure to large corporates, and these corporates could continue to take legal recourse to delay recovery proceedings, which would challenge effective resolution within the proposed timeline of 180 days. It would also mean that the code is unlikely to alleviate the current asset quality problems of banks anytime soon.

But in the long run, Crisil said the code will structurally hasten the resolution of weak assets (currently forecast at about Rs. 8 lakh crore by March 31, 2017) problems, thereby releasing precious capital for the banking system, which, in turn, will encourage credit expansion.

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