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April 01, 2016

How Bankruptcy Code Will Save Lenders

In this livemint article, Anjali Sharma and Susan Thomas discuss how the proposed Bankruptcy code with its focus on the speedy resolution could have helped lenders in the Kingfisher Airlines case.


Excerpts from the article are below


"Robust banking regulation and a sound bankruptcy process share a common goal: to recognize bad news and act quickly. This is not the driving principle in the current Indian bankruptcy regime..."


"The failure of the Kingfisher House auction is then perhaps about the angst of banks. The auction failed because the bid price set by the lenders was higher than the market price by at least three times. What might explain this? Perhaps the assets are being carried on the books of banks at inflated values, and banks are not keen on revealing the bad news and recognizing a large loss.


This is a failure of banking regulation, which needs reforms. The moment there are failures to repay, banking regulation must incentivize banks to rapidly recognize losses up front. This ensures that the valuation of banks, as seen in the public domain, is always conservative. Any recovery that takes place in the future is pure upside. Technically, robust regulation needs to be backed up by technically sound supervision, where the Reserve Bank of India inspects the books of banks, and block banks when they try to cover up."


"A key design focus in the proposed Insolvancy and Bankruptcy Code (IBC) is speed of resolution. Delay is disincentivized at various stages in the process. Let us start at the first date of default. The Insolvency Resolution Process (IRP) can be triggered by any creditor— not just banks alone—on the date of the first default. This is unlike mechanisms in SARFAESI (the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest) Act, 2002, where banks can wait for 90 days before designating a default account as non-performingasset, and have to wait for 30 days before taking action. The IBC empowers even operational creditors including employees and trader creditors to trigger the process. The earliest publicly observed default by KFA was on employees’ salaries. Under IBC, default to employees can be used to trigger resolution. The possibility of this will help keep banks honest."


"....if we imagine how Kingfisher Airlines would have worked under the proposed Insolvancy and Bankruptcy Code (IBC), it is likely that the outcomes would have been better, even if there is no progress on banking reform or public sector bank privatization. The bankruptcy reform, in and of itself, is beneficial. At the same time, it is a complex reform that will require a strong team to oversee the implementation, which includes perfecting the draft law, and setting up working groups or task forces to build the institutional infrastructure to enforce the law. Moreover, it is one of the critical pillars of a mature market economy."


Read full article here

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