IBC has failed; will a bad bank succeed?

Faced with the prospect of dramatic rise in stressed assets of public sector banks (PSBs), about which the RBI warned in its recent report, the government is setting up yet another resolution mechanism. It proposes a bad bank under the ARC (Asset Reconstruction Company) and AMC (Asset Management Company) model in which ARC will aggregate all stressed assets and transfer them to AMC for resolution.  

Post-2014, the government has tried three debt resolution mechanisms: (i) Strategic Debt Restructuring (SDR) scheme of 2015 which allows creditors to take over firms unable to pay and sell them to new owners (ii) Sustainable Structuring of Stressed Assets (S4A) of 2016 which lets creditors take 50% haircut to restore the financial viability of firms and (iii) Insolvency and Bankruptcy Code (IBC) of 2016 which either revives (resolution) or closes (liquidation) indebted firms.

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The first two had failed by FY17, primarily because of governance failures as the Economic Survey of 2016-17 explained at some length. It was silent on the IBC since those were early days and strongly recommended a centralised (public sector) bad bank, which it called “Public Sector Asset Rehabilitation Agency” or “PARA” to “take charge of the largest, most difficult cases, and make politically tough decisions to reduce debt”.

The government is now headed in this direction but to understand why one needs to look at the performance of IBC.  

At 21% debt recovery, IBC is worse than UPA-era’s 25%   

The IBC has been stopped from initiating fresh corporate insolvency resolution process (CIRP) until March 24, 2021, by the government and apex court orders prompted by the pandemic-induced economic disruptions. The IBC regulator, Insolvency and Bankruptcy Board of India (IBBI), provides details of stressed asset resolution until September 2020 (Q2 of FY21).  

The IBBI’s data shows that the total number of CIRP cases admitted for the IBC proceedings stood at 4,008 (from FY17 to Q2 of FY21). Most of these cases are from manufacturing (41%), real estate, renting, and business activities (20%).  

Of these 4,008 cases, 277 ended in resolution (firms continue as going concerns) and 1,025 in orders for liquidation.

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The following graph maps “admitted” claims of financial creditors (FCs) and “realisable” amounts from the resolution and liquidation processes.  

As is clear in the graph, the total claims were Rs 10.48 lakh crore (Rs 4.34 lakh crore plus Rs 6.14 lakh crore) and the “realisable” amount Rs 2.2 lakh crore” (Rs 1.89 lakh crore plus Rs 0.31 lakh crore). This means the total haircut is the rest Rs 8.3 lakh crore.

At this rate, the debt recovery works out to be 20.9% (79% of haircut).  

This debt recovery rate is far lower than the much-reviled UPA-era debt resolution processes when the recovery was 25% (and haircut 75%). The IBBI repeatedly reminded this in its reports to justify the IBC.  

There is yet another downside to it.

Most of the debt claims ended in liquidation – Rs 6.8 lakh crore or 59% of the total claims.  

Besides, out of Rs 18,916.9 crore of debt claims for which the liquidation process has been completed, only Rs 280 crore was actually “realised” – a recovery rate of 1.5% (haircut of 98.5%). The remaining Rs 5.95 lakh crore is under the liquidation process.

Liquidation is, thus, a triple whammy for the economy: Loss of credit/loan, loss of business and loss of jobs too.  

Diluting IBC and weakening RBI  

Why the IBC turned out to be worse than the notorious UPA-era of restructuring and ever-greening bad loans is for detailed investigation by forensic and insolvency experts.

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But enough evidence exists to suggest that the IBC is likely to go further downhill from here. There are three major…