In recent months, historic economic reform of the past decade has come under fierce criticism from various quarters. The Insolvency and Bankruptcy Code (IBC), touted as a panacea to the debilitating bad debt problem that had crippled India’s financial system, has been attacked as ineffective at best and counterproductive at worst. While vocal, rhetorical and political arguments have been made against the IBC on the basis of anecdotal evidence, a reform as radical and complex as this deserves a more objective and data-rich assessment.
The main criticism against IBC has been because of its allegedly paltry paybacks, which many critics claim makes IBC a legal chimney instead of a powerful tool for creating economic value. Objectively speaking, this argument rests on several fragile assumptions. In any bankruptcy process, collections are influenced by a multitude of macroeconomic and company-specific factors. This is because asset values are not constant and change depending on the broader economic environment and the competitive dynamics of the industry in which the company operates. Therefore, to truly assess the IBC on recoveries, one would need a diverse data set spanning multiple industries and business cycles. Since this data is not yet available, an IBC assessment of recoveries is likely to be biased. Even if one ignored this bias, its recoveries are not as dismal as it is claimed. According to data from the Reserve Bank of India (RBI), for the three years of IBC use, recoveries have averaged around 45%. Many have criticized the IBC for arbitrarily declaring this number low. Some seller-side research companies have made an even more specious point, stating that excluding major accounts, IBC recoveries are 24%. Others have bizarrely cited individual cases where collections have been very low to declare that the Code has failed. These critics must remember that in economics as in so much of our lives, absolute numbers don’t make sense, and every process has a distribution of outcomes that can be skewed, and hand-picked anecdotes don’t make up not a convincing argument. IBC recovery can only be assessed against a benchmark. For more robustness, we can use several benchmarks to assess recoveries within the framework of the IBC and arrive at a less biased estimate of its efficiency.
One benchmark is the proportion of recovery under alternative mechanisms. As RBI data shows, average recoveries for Asset Reconstruction Companies (ARCs) under the Securitization and Reconstruction of Financial Assets and Enforcement of Collateral Act (SARFAESI) have only exceeded those at the IBC only once in the 17-year period ended in 2020, and have largely languished. less than 30% during this period. Likewise, debt collection courts have only exceeded the 45% collection mark three times in that 17-year period and have stagnated with single-digit collection rates in recent years. Therefore, to the extent that data is available, IBC recovery rates have not been abnormally low, but in fact higher than the historical averages of alternative resolution mechanisms.
While it is true that there are large variations in collection rates among the sample, this is true for any bankruptcy process. Viral Acharya, Sreedhar Bharath and Anand Srinivasan (“Does industry-wide distress affect failing companies? Evidence from creditor recovery”, Journal of Financial Economics, 2007) find that for 1,511 bankruptcies of American companies between 1982 and 1999, the average recovery rate was 51.1% and the standard deviation of this rate was 36.6%, implying that there were many observations with extremely low and high recoveries, just like in the case of the CIB.
Likewise, a comprehensive special report by Moody’s (“Corporate Default and Recovery Rates”, 1920-2010) shows that the average recovery rate in American bankruptcies between 1982 and 2010 was 59.6% for senior bank loans. , 27.9% for second-tier banks. loans, 39.9% for unsecured bank loans, 49.1% for covered bonds, 37.4% for senior unsecured bonds and 25.3% for senior subordinated bonds. Against the background of these numbers, the performance of the IBC, at least on the recovery dimension, is quite impressive. Falcon-eyed skeptics will argue that senior loan collections are much higher than IBC’s, exposing its ineffectiveness since all bankruptcies in India are on bank loans. Such an argument ignores the fact that unlike the United States, where banks are well informed and corporate bonds are subject to free market discipline, most loans in India are issued by ill-informed “sarkari” bankers. and poorly motivated and issuing such loans often carries the stench of political influence and corruption. Many loans are secured by the “personal guarantees” of the promoters and are therefore unsecured for all practical purposes. Therefore, many loans in India lose value at the time of disbursement and not because of the IBC at the time of collection. Despite the loss in value at issue, on average IBC’s recovery rates are comparable to those in the US bankruptcy process, long considered the gold standard for it.
So, despite the limitations of data retrieval, the censorship and stigma that Indian IBC has suffered is totally unwarranted and misguided. In the second part of this article, I will discuss other critiques of the law and explore a major gap in the IBC framework that needs to be filled to refine its effectiveness.
Diva Jain is a director at Arrjavv and a “probabilist” who researches and writes on behavioral finance and economics. His Twitter handle is @ Divajain2
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