India has a history of financial transactions since the Vedic age. Money was an instrument of care. Manu said “an insensible should deposit his money with a person of good family, of good character, well acquainted with laws….” Lending and saving started when humans started material exchanging.
English banking law lent a lot to Indian banking law. Banking law has within it the elements of Contract Act, other commercial and civil laws. The amendment to Reserve Bank of India Act in 2006 brought in the cash reserve ratio principle and vested unto it specific powers to issue guidelines and circulars binding on all banks.
The economic reforms that began in 1991 changed India’s business and commercial roadmap and resulted in free entry and exit of enterprises, inflowand outflow of resources and productive use of investments. Here, the bank became the growth drivers. The banks were exposed to many a risk involving credit, liquidity, interest, operational and market. The predominant among these was debt recovery.
Emergence of Mounting NPA
Though the banks strengthened their position through better appraisal process, yet the incidence of non performing assets (NPAs) increased. This certainly adversely affected profitability of banks. Slowly, it became a serious problem, hitting worst the public sector banks. To this there is a linkage – corporate India started falling sick as its ability to pay interest on its debts weakened (Credit Suisse Report). This bouncedback on the banks further by accumulating its non performing assets. During the past three years, there has been a steady increase in NPAs (Credit Suisse Report). The companies whose interest coverage was less than one per cent for four or more ofthe past eight quarters, was at 33%, up from 29% from the previous quarter. Needless to say, interest coverage denotes a company’s ability to pay interest on its loans, the failure whereof turns the loan into a non-performing loan/asset.
Referring again to the Suisse Report, based on the sample of 3,700 listed non-financial companies with an aggregate debt of $ 500 billion, the Companies that have an interest coverage of less than one, the share of chronically stressed companies has increased to $ 160 billion. Similarly, the share of debt with companies that have interest coverage of less than one for 11 of the past 12 quarters has increased to $ 85 billion up from $ 67 billion in the previous quarter.
As of June 2016, the total amount of Gross Non-Performing Assets for public and private sector banks is around rupees six lakh crore. Top twenty NPA accounts of public sector banks then stood at`1.54 lakh crore (The Hindu, November 21, 2016). If we look back, it can be seen that the deterioration started seriously since 2009. By March 2016, the situation was back as in 2002-03. The lowest levelof NPAs was in 2007-08 and 2008-09 (Handbook of Statistics on Economy, RBI). Asset quality of scheduled commercial banks by March 2016 showed that it is beyond the financial sector in India and it is effectively a fiscal risk, imposing a burden on the already stressed State Exchequer.
The recovery actions bycreditors especially the Public Sector Banks despite enactment of special laws such as the Recovery of Debts Due to Banks and Financial Institution Act, 1993, Securitization and Reconstruction of Financial Assets & Enforcement of Security Interest Act, 2002, of the Sick Industrial Companies (Special Provisions) Act, 1985 and the winding up provisions under the Companies Act, 1956 did not yield requisite results. The Presidential Towns Insolvency Act, 1909 and the Prevention Insolvency Act, 1920 were of the pre-independence era.
The Insolvency and Bankruptcy Code 2016, which received the Presidential assent on May 28, 2016, is an enactment “to consolidate and amend the laws relating to reorganization and insolvency resolution of corporate persons, partnership firms and individuals in a time bound manner for maximizing of value of assets of such persons, to promote entrepreneurship, availability of credit and balance the interests of all the stakeholders including alteration in the order of priority of payment of the Government dues…”
Considering the need and timeliness of the Code, one has no reason to disbelieve what Dr. M.S. Sahoo, Chairperson of Insolvency and Bankruptcy Board of India says in the first issue of Insolvency and Bankruptcy News (Vol.1, October-December 2016):
“It is necessary to have amechanism whereby the inefficient or defunct firms vacate the space and release the idle resources for efficient uses in an orderly manner. In the absence of a mechanism hitherto, there are quite a few firms stuck in unsustainable business or with no business and idle assets.
It has been a paradox that an economy, which allowed free entry and free competition, did not permit free exit and in the process suffered the inefficiencies of several zombie entities in the system for so long. The third pillar has now been erected in the form of Insolvency and Bankruptcy Code, 2016. This code offers a market directed, time bound mechanism for resolution of insolvency, wherever possible, or exit, wherever required, and thereby ensures freedom to exit.”
The new Code’s objective is to promote entrepreneurship, availability of credit and to look after the interests of all stakeholders and amend the laws relating to insolvency resolutions not confined to corporate functions but also partnerships and individuals in a time bound manner, and to maximize value of assets of such entities. Thus, a single piece of legislation earlier contained in different Acts has been brought into bring greater clarity in law and facilitate application of consistent andcoherent provisions to all stakeholders whether affected by failure of business or inability to pay debts.
Insolvency and Bankruptcy Code
Last month the Government proclaimed an ordinance giving wide ranging powers to the Reserve Bank to issue directions especially to public sector banks to resort to the Code under guidance of RBI’s Internal Advisory Committee, on specific account(s) which need to go before the Adjudicating Authority under the Code. The banking system which is currently sitting on stress loans worth lakhsof crore would benefit if steps in terms of the Insolvency Code, 2016 are taken. Under the Code even the Corporate Debtors have an option to move the Adjudicating Authority under the Code. Under the Code default is a state of insolvency. The failure and consequent insolvency can be prevented and can be resolved either as a going concern and if it has already reached the irresolvable proportions, the answer is liquidation. The Code addresses all these aspects, namely, preventing insolvency, providing a market determined and time bound mechanism for reconstruction and resolving insolvency wherever it is possible. It promotes ease to exit. The Committee of Creditors along with Insolvency Professionals play a predominant role. The time limit provided under the Code gives it a clear distinction from all earlier legislations. The Code permits 180 days for resolution of insolvency process with only one time extension upto ninety days in exceptional circumstances or deserving cases. The Code also provides a fast track process for certain categories of corporate persons with resolution process to be completed within ninety days with one time extension of 45 days.
The Corporate Debtors will be well motivated to use the provisions of the Insolvency and Bankruptcy Code, 2016, and their failure will not come in their way to participate in the new restructured scheme, provided their creditors still have faith in them. This will bring about resolution and restructure their finances, thereby putting their Non-Performing Assets into use which ultimately will help them to re-build their economy. There will be a high order of discipline and amiable decisions without fear of any investigation.
The Code can certainly bring about two definite changes. Public Sector Banks andfinancial lenders would be eager to take decisions under the Code for a resolution mechanism. Some apprehensions can be there. For example, there may be no buyers to take the assets in a particular sector, and future cash flows. All these would be within the domain of the Committee of Creditors themselves and can be solved with the help of the insolvency professionals. The time period of six months would be available to them to resolve the issues and get back to the main stream with the resolution in place, failing which liquidation would be the consequence.
The changes around cannot be ignored. In 2012, the interest rate was 12.8%. As per the Code, it is now 6.25%.
There can be teething troubles considering the tasksunderlying the Code. But bad weather cannot threaten ordeter all ships.
— Member, Advisory Committee, Insolvency and Bankruptcy Board of India, Former Additional Solicitor General of India