New Bankruptcy Law Will Boost Home Loan Market

In any economy, the nature of products that banks offer is determined by, among other things, their own financial health and the overall stress in the system. That is also true of home loans, especially under the present MCLR (marginal cost of fund-based lending rate) regime, where the rates that lenders offer on their loan products are linked to their cost of raising funds.

In this context, the bankruptcy law and insolvency code, 2016, passed by the Rajya Sabha last week, is seen as a crucial piece of legislation. The code, now a Bill, promises to make it easier to wind up a failing business and recover debts in Asia's third-largest economy. The country's banks, reeling under a huge weight of bad loans for the past few years, will get a major shot in the arm from this.

As at the end of the October-December quarter of 2015-16, the listed banks together had on their balance sheets more than Rs 1 lakh crore of non-performing assets (NPAs) – that is about six per cent of their total gross advances. The trend was largely unchanged in the January-March quarter.

MakaanIQ takes a look at how the bankruptcy law and insolvency code will help banks lower their bad loans and improve their financial health.

What is the new legislation?

Since India currently has multiple laws to deal with insolvency, there have been significant delays in winding up of companies. The bankruptcy code will consolidate the existing framework and create a new institutional structure.

The insolvency statute is characterised by a legal regime providing for both reorganisation and liquidation. It contains mechanisms for debtors to make proposals to their creditors for the adjustment of their debt.

The new legislation will create a new class of insolvency professionals who will help sick companies and banks with a smooth takeover of an insolvent company and manage the liquidation process.

The Bill proposes setting up of an entity, the Insolvency and Bankruptcy Board of India (IBBI), to regulate insolvency professionals and store all credit information of corporate entities.

Competency and challenges

The main challenge will be creating a specialised large pool of insolvency professionals to help with quick implementation of the new law. The new regulator (IBBI) will also need to draft procedural rules for insolvency professionals and information utilities, among others.

The code also proposes to protect workers in case of an insolvency; they get a priority (in terms of payment of salaries) during the liquidation of assets.

In the event of an insolvent debtor having assets abroad, the Indian government can enter into an agreement with other countries to ensure enforcement of the law.

India stands 136th in the World Bank's latest resolving insolvency ranking – much behind China (55), where it takes one year and seven months to resolve insolvency. The new law, which stipulates a time limit for the bankruptcy process, could also help India improve its ranking.

Expert take

Finance Minister Arun Jaitley was recently quotes as saying: “Bad loans in the Indian banking system have peaked and the situation will improve in the coming months as stressed industrial sectors turn around… Once the sectoral balance sheet improves in some of the sectors, I think the non-performing assets (NPAs) will start tapering down. The peaks probably have been reached, or thereabouts.”

He had pointed out that sectors like steel, highways, power and sugar have been under stress and exposure to them is being reflected in banks' balance sheets.

According to media reports, Ashwin Bishnoi, a partner at law firm Khaitan and Co, had said: “The insolvency code proposes a vast change and its implementation will take time”.

Karthik, partner, financial advisory services, Deloitte Touche Tohmatsu India LLP, was quoted as saying: “Having a robust insolvency-resolution mechanism can help creditors recover a larger part of their investment faster, allowing them to re-invest in other businesses, thereby facilitating the efficient flow of capital across the economy”.

“Both Houses of Parliament passing the Bankruptcy Code... this is huge. Combined with bank clean-up, (it can be a) potential game changer in the long run,” economist Sanjeev Sanyal had said. The Bill comes amid mounting concerns over NPAs of state run banks.

Mohit Saraf, senior partner, Luthra & Luthra, had said: “This will also lessen the burden on state-run lenders, which are already saddled with bad loans.” The key features of the code include hastening debt recoveries and restructuring by setting a 180-day deadline to decide the fate of a defaulting company.