In recent months, a landmark economic recovery of the last decade has been criticized from various quarters. The Insolvency and Bankruptcy Code (IBC), which was touted as a panacea for the debilitating problem of bad loans crippling the Indian financial system, was attacked as being ineffective at best and counterproductive at worst. Is. While vocal, rhetorical and political arguments have been made against the IBC based on anecdotal evidence, a reform is as radical and complex as it deserves a more objective and data-intensive evaluation.
The primary criticism against the IBC has been due to its allegedly modest recovery, which according to many critics makes the IBC a legal enchantment rather than a powerful tool for economic value creation. Objectively speaking, this argument rests on several delicate assumptions. In any bankruptcy process, recovery is influenced by a host of macroeconomic and firm-specific factors. This is because asset values are not fixed and change according to the competitive dynamics of the larger economic environment and industry within which the firm operates. Therefore, to truly evaluate IBC on recovery, diverse data sets spanning multiple industries and business cycles will be needed. Since such data is not yet available, the IBC’s assessment on recovery is likely to be biased. Even if this bias is ignored, its recovery is not as disappointing as it is being reported. According to the Reserve Bank of India (RBI) data, in the three years using IBC, the recovery averaged around 45%. Many have criticized the IBC by arbitrarily declaring this number low. Some sell-off research firms have made an even more specific argument, saying that excluding head accounts, the recovery under IBC is 24%. Others have cited oddly isolated cases where recovery is too short to declare that the code has failed. These critics should be reminded that, in economics, as in most of our lives, absolute numbers are meaningless, and every process has distributions of outcomes that can be skewed, and cherry-picked anecdotes are not a compelling argument. give. Recovery under IBC can be assessed with respect to only one benchmark. For robustness, we can use multiple benchmarks to evaluate recovery under IBC and arrive at a less biased estimate of its effectiveness.
A benchmark is the recovery ratio under the alternative mechanism. As data from RBI shows, the average recovery for asset reconstruction companies (ARCs) under the Securitization and Reconstruction of Financial Assets and Security Interest (SARFAESI) Act is only once in the 17-year period ending 2020 for those under the IBC. The people have been exceeded, and substantially reduced. less than 30% during this period. Similarly, debt recovery tribunals crossed the 45% recovery mark only three times in this 17-year period and have ended up with single-digit recovery rates for the past few years. Therefore, to the extent that data is available, the IBC recovery rate is not unusually low, but actually higher than the historical average of alternative resolution mechanisms.
While it is true that recovery rates vary widely among samples, this is true for any bankruptcy process. Viral Acharya, Sridhar Bharat and Anand Srinivasan (‘Does the Industry-Wide Crisis Affect Defaulting Firms? Evidence from Creditor Recovery’, Journal of Financial Economics, 2007) found that between 1982 and 1999, 1,511 US corporate bankruptcies accounted for , the average recovery rate was 51.1. % and the standard deviation of this rate was a whopping 36.6%, meaning that there were many observations with very low as well as high recoveries, such as in the case of IBC.
Similarly a comprehensive special report by Moody’s (‘Corporate Default and Recovery Rates’, 1920–2010) shows that the average recovery rate of US bankruptcies between 1982 and 2010 is 59.6% for first-lien bank loans, compared to second- The lien for the bank was 27.9%. Loans accounted for 39.9% for unsecured bank loans, 49.1% for secured bonds, 37.4% for senior unsecured bonds and 25.3% for senior subordinated bonds. In the context of these figures, the performance of IBC is quite impressive, at least on the dimension of recovery. Hawk-eyed skeptics would argue that the recovery for first-lien loans is much higher than for the IBC, highlighting its ineffectiveness as bank loans are involved in all bankruptcies in India. Such an argument ignores the fact that unlike the US, where banks are well informed and corporate bonds are subject to free market discipline, most loans in India are made by uninformed and poorly promoted ‘government’ bankers. are issued and often such loans are issued. Tolerates the stench of political influence and corruption. Many loans are secured on the ‘personal guarantee’ of the promoters and are therefore unsecured for all practical purposes. Hence many loans in India lose value at the time of disbursement and not at the time of recovery due to IBC. Despite the value loss upon issuance, on average, IBC recovery rates are comparable to those in the U.S. bankruptcy process, which has long been viewed as the gold standard for it.
Thus, despite the limitations of the retrieval data, the condemnation and humiliation that has been brought to the IBC of India is wholly unwarranted and misguided. In the second part of this article, I will discuss other criticisms of the law and explore a major gap in the IBC framework that needs to be filled in order to accelerate its effectiveness.
Diva Jain is a director at Arjav and is a ‘probabilist’ who researches and writes on behavioral finance and economics. His twitter handle @Divajain2 . Is
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