An analysis of the bankruptcy code and its effect on the banking system necessitates a prior understanding of the current scenario with regard to the Non- Performing Assets (NPA’s) between banks and the loan division’s recovery process. The banking system of any economy plays a very crucial role in the economic growth and its sustainability. During the World Global Financial crisis, majority of the banking systems had collapsed. But India’s banking system was rigid, and had sustained itself in the harsh conditions, therefore rising to become a very strong banking organisation. However, this robustness was challenged when the economy saw an increase in NPAs in various banks.
A debt is classified as an NPA when the payment of interest or the principal is not made within ninety days of the maturity. The government tried hard and had opened various institutions for the governing and collection of NPAs, such as Sick Industrial Company Act (SICA) Lok Adalat and Debt Recovery Tribunal (DRT), but none of these have proved efficient enough in handling the economic status. In 2016, the BJP government took a historic step towards improving this situation, leading to the emergence of the ‘Insolvency and bankruptcy code’ to amend the existing laws and create a unified legal framework. Bankruptcy is a legal term used by the courts for those individuals or a company who are unable to pay their debts.
As India is a capital famished country, it is important that the capital is not dissipated away on weak businesses. Hence, proper regulation is important for quicker resolutions of bankruptcy. The major step taken by the government was the SICA, which aimed at looking for sick companies, and providing quick resolutions for their revival or making them go for liquidation. SICA terms a company as ‘bad’ only if its net worth is eroded by 51%. Generally, if half of the company’s worth is eroded, it is very difficult for it to survive in the market and has no other option but to liquidate. This contradicts its own notions of quicker resolutions while it also had to follow processes of legal intermediaries (people’s court) and DRT resolutions.
The need was for prompt actions and hence, the SARFAESI Act was created. Under this Act, the banks took possession of the assets of the firm and could sell them for recovery of loans. As the court’s role was reduced, the whole process could be initiated faster. Due to some inefficiency in the system, there were not proper regulations of these Acts making them slow with longer winding up time. The involvement of the courts and the debt tribunals made the system more complex and difficult to handle. The insolvency and bankruptcy board involves the Insolvency Recovery Process, (IRP) which can be initiated by any creditor (financial or non- financial firm, employee or individuals). The creditor first insures the viability of the firm, whether the firm can revive or needs to be dissolved.
As soon as a company files for bankruptcy the National Company Law Tribunal (NCLT) appoints a professional to take care of the situation. The professional takes over the management of the company and operates the company assuming the growing concern concept. This involves taking all the necessary decisions for reviving the business, such as bringing in finances by bidding commercial contracts. The professional has a limit of 180 days to revive the business after the company’s dissolution process starts. By bringing in this Act, many of the inefficiencies of the system have been taken care of, including time and effort of court proceedings. Once this system starts, a lot of money will automatically start flowing in the system from various non-finance players.
Even venture capitalists and private equity players would be interested in the corporate debt market. The bankruptcy law is a milestone in the Indian financial system, but governing an implementation is a bigger challenge. Currently India ranks 136 out of 189 countries on the World Bank’s index in the ease of resolving bankruptcies. So there is a long way to go before reaching the stated goal. The bankruptcy code has its own flaws and should not hurt the current economic activity, because its main role is to bring efficiency in the system. The code is bound to improve India’s overall ranking around the globe.
Picture Courtesy- The Economic Times