Synopsis: The Insolvency and Bankruptcy Code (IBC), which was promoted as a panacea to the problem of bad loans, has been attacked as being ineffective at best and counterproductive at worst. It requires a more nuanced debate.
In recent months, a landmark economic reform of the last decade has come under criticism from various quarters.
However, a reform as radical and complex as this deserves a more objective and data-intensive evaluation.
Why the criticism of IBC is unwarranted?
Arbitrary assumptions: In any bankruptcy process, recoveries are impacted by a host of macroeconomic and firm-specific factors. According to Reserve Bank of India (RBI) data, for the three years, recoveries averaged around 45%. Many have criticized the IBC by arbitrarily declaring this number as low.
Biased opinions: To truly evaluate the IBC on recoveries, one would require a diversified data set about several industries and business cycles. Since such data is not available yet, an evaluation of the IBC on recoveries is likely to be biased.
Absolute numbers are meaningless: Critics must be reminded that, every process can have a distribution of outcomes.
Wide variation in recovery rates is true for any bankruptcy process: Journal of Financial Economics, 2007, find that for US corporate bankruptcies between 1982 and 1999, the average recovery rate was 51.1% and the standard deviation of this rate was a large 36.6%.
A, special report by Moody’s shows that the average recovery rate in US bankruptcies between 1982 and 2010 was 59.6% for first-lien bank loans, 37.4% for senior unsecured bonds and 25.3% for senior subordinated bonds.
Poorly incentivized banking system: Most loans in India are issued by uninformed and poorly incentivized ‘sarkari’ bankers, and the issuance of such loans often based on political influence and corruption.
What is the way forward?
Using benchmarks: First, for robustness, we can use several benchmarks to evaluate recoveries under the IBC and arrive at a less biased estimate of its effectiveness.
Second, use recovery proportion under alternate mechanisms as benchmark. As RBI data shows, average recoveries for asset reconstruction companies (ARCs) under SARFAESI Act surpassed those under IBC just once in the 17-year period, and have largely languished under 30% during this period.
Therefore, to the extent that data is available, IBC recovery rates have not been abnormally low, but in fact higher than historical averages of alternate resolution mechanisms.
Source: This post is based on the article “Criticism of the IBC’s recovery record is unwarranted” published in Livemint on 14th September 2021.