A performance appraisal of IBC

A performance appraisal of IBC

Context: Recently, an article in Business Standard discussed the effectiveness of India’s Insolvency and Bankruptcy Code (IBC), 2016.

Background:
• It has figured out how well the IBC resolved financial distress in companies, improves bank balance sheets,
and benefits the economy, despite some challenges in efficiency and asset value realization.

What is the IBC?
• The Insolvency and Bankruptcy Code was enacted in 2016, and it replaced all the existing laws with a uniform procedure to resolve insolvency and bankruptcy disputes.
• The code aimed to address the issue of Non-performing Assets (NPAs) and debt defaults.
• The primary goal of the IBC is to streamline and expedite the resolution of insolvency and bankruptcy disputes in a time-bound manner.

How has IBC fared?
• Reduction in Non-Performing Assets (NPAs): The IBC helped decrease the NPA rate of banks significantly, from a peak of 14.8% in September 2018 to a low of 3.2% by September 2023.
• Increase in Bank Profits: Banks experienced a turnaround, achieving a historic profit of €2.63 trillion in 2022-23, compared to a loss in 2017-18.
• Improvement in Corporate Balance Sheets: Post-IBC, firms showed enhanced performance with more robust balance sheets, better leverage management, and an improved interest coverage ratio exceeding 3.5.
• Enhancement in Corporate Governance: IBC led to improved corporate governance, evidenced by a reduction in related party transactions, as highlighted in a post-IBC study.
• Global Ranking Improvement: India’s ranking in global insolvency resolution improved drastically, moving from 136th to 52nd within the first three years of the IBC’s implementation.
• A Cultural reset: The IBC has played important role in shaping the behavior of borrowers. Before IBC, the recovery mechanisms available to lenders were through Lok Adalat, the Debt Recovery Tribunal and the SARFAESI Act. Earlier, there was a low average recovery of 23%, while under IBC it has risen to 43%.

What are the problems with IBC?
• Inefficient Time Management: IBC’s resolution processes are prolonged, averaging 867 days, far beyond the intended 180 days.
• High Incidence of Liquidation: IBC results in more liquidations than rescues, especially impacting already sick or defunct companies.
• Methodological Issues in Appraisal: Some appraisals of the IBC’s performance use flawed methodologies, like focusing solely on recovery rates.
• Gap in Asset Value Maximization: Resolutions are realizing only 86% of the fair value of the companies, highlighting a shortfall in achieving the desired value maximization.

Way Forward
• The focus should be on time-bound resolutions, better realization of the value of stressed assets and stakeholders involved in the IBC must play their roles more effectively.