Haircuts and Settlements

Source: Business Standard 

Relevance: The insolvency and Bankruptcy Code (IBC) is an important mechanism to protect the economy from NPA and failed businesses. Any issue in this mechanism will act as a big hurdle in the economic development of the country.


The Insolvency and Bankruptcy Code (IBC) allows for a system of haircuts and settlements. However, experts have expressed concerns over their misuse which demands a robust reformation of the IBC process. 


  • India’s bankruptcy process under the Insolvency and Bankruptcy Code (IBC) is relatively new and should be seen as a work in progress.
  • Experts have expressed concerns about the magnitude of haircuts that banks are taking under the IBC resolution process. Also, the system of one-time settlement (OTS) is harmful. 
Issue of Haircuts:
  • In finance, a haircut refers to the reduction applied to the original loan amount during the insolvency resolution settlement.  
  • Overall, haircuts have been in the 80 percent range. Banks have lost four-fifths of the money they have lent to companies that have entered the IBC process.
  • Even the National Company Law Tribunal recently expressed surprise that Vedanta’s Anil Agarwal was “paying almost nothing” to take over Videocon Industries. 
Issue of One-time Settlement (OTS) Mechanism:
  • Under IBC, 90 percent of the committee of creditors (CoC) can decide to give the firm back to the promoter. 
    • The recent OTS between the promoter of Siva Industries and Holdings Ltd and its creditors is one such example. The promoter paid Rs 500 crore against a Rs 5,000 crore loan and got back the firm.
  • The mechanism is beneficial as:
    • It preserves capital and involves an agreement of the original lenders, 
    • It also takes the pressure off the tribunal, which is clogged up with cases.
  • However, the OTS mechanism to settle cases can be open to subversion as the mechanism attracts minimum legal oversight.
    • The promoters could borrow money from banks, take it out of the company, and then use the OTS mechanism to have the banks take a massive haircut on the loans.
Way Ahead:
  • Any further reform of the IBC process must take into account the basic motivation for its introduction: 
    • Firstly, to preserve the companies as far as possible.
    • Secondly, to ensure that capital is not wasted or locked up in legal proceedings.
    • Third, to introduce some market discipline in bank’s corporate lending.

The ideal solution is the development of an incentive-compatible banking sector that lends more carefully. But until public sector banking in India occupies a far smaller share of corporate lending, such incentive compatibility is a distant dream.

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