The year 2017 saw many important structural reforms being implemented in the country. The introduction of GST was a landmark event and will go a long way towards achieving indirect tax reforms. Similarly, the Real Estate Regulatory Authority will bring a lot of transparency in the real estate sector, thereby affecting a large number of Indians who aspire home ownership. One reform that is both influencing and changing the way one does business in India is the introduction of the Insolvency and Bankruptcy Code (IBC).
Promoters of Indian business have taken lenders for granted and benefited from a tedious legal system (as on March 31, 2017, gross NPAs were almost Rs 8 lakh crore). IBC has changed the rules of the game and provided enough ammunition in the hands of bankers to recover dues. It was passed by Parliament in May 2016 and became effective in December 2016. Since then, the Insolvency and Bankruptcy Board of India, the regulator, has demonstrated tremendous agility in the implementation of IBC. It is also one of the rare examples where the government, regulators and market participants have come together to tackle an issue that has caused material losses to the financial system. The government has demonstrated it is offering unconditional support to IBC and is monitoring its progress and impact.
While IBC seems to be progressing with all the right intentions, there remain question marks over its actual effectiveness. It is still early days, but when dissected and put under the microscope, concerns are being raised over its long-term effectiveness and the likelihood of it having the same fate like other initiatives (BIFR, DRT, CDR, SDR, etc).
The code in its current form (and with frequent changes) seems to focus primarily on large NPAs. The first 12 accounts (the dirty dozen, as they are called) that were referred to IBC were triggered by a significant nudge from the central bank. The regulator has released another list of 28 accounts that are supposed to follow the same course as the first 12. Also, the decision to keep promoters out of the resolution process, while signalling strong governance, raises questions.
* How will this affect valuation? Keeping a key bidder away from the resolution process can affect valuations negatively. While there are contrasting views that, with promoters out of the way, other interested bidders will be more aggressive as they see a higher probability of acquiring control, you can’t ignore that promoters had significant financial interest in the business and their involvement would make the resolution process more competitive.
* What happens to the fate of smaller accounts? Based on current investor interest and the profiles of defaulting companies, there may hardly be any takers after the top 25-30 NPAs. This puts many companies referred to IBC under the risk of liquidation and likely destruction of value.
* By blocking promoters, are we increasing the risk of large, prolonged legal disputes?
* Does this not question the very existence of IBC? If the promoters become irrelevant to the resolution process, the process may well become redundant if banks and promoters start settling without approaching IBC.
Instead of keeping promoters out of the resolution process, one option could be to instead negatively mark existing promoters under the selection criteria.
Another challenge with IBC is that while it allows formal resolution of an NPA, ensuring efficient distribution and use of capital, it ignores the fact that a large chunk of the loan will be written off. Who is accountable for this loss? There is no indication of IBC trying to address promoters’ malfeasance and it lets off the perpetrators by focusing on resolution and not on their action (fraud) which led to the account becoming an NPA. It, in a way, legitimises the haircuts taken by banks which they were hesitant to take prior to IBC. I believe the entire IBC process and the overall governance environment in the country will be stronger when the system ensures that the threshold of tolerating fraud is very low and all stakeholders are held accountable for their actions.
The next couple of months will be critical for IBC as most of the top 12 accounts will complete the requisite 270-day cycle. The honeymoon period for IBC is over, now the real battle sets in. While it has all the right intentions, does it have the courage to withstand the might of promoters?