The global financial news reveals an increase in bankruptcies due to the Covid-19 induced global lockdowns. While the bankruptcies are unfortunate, a recognition of the bankruptcies facing companies in the face of the collapse and an efficient resolution of such bankruptcies (which will allow both the companies and creditors involved to move along) is vital to rejuvenating the economy.
Media reports suggest that the government may amend the Insolvency and Bankruptcy Code (IBC) to suspend up to six months provisions that allow for insolvency proceedings to be triggered against defaulters. The ramifications of such a decision must be carefully analysed. While IBC proceedings were rightly stopped during the lockdown, the IBC must become fully functional as soon as possible in the post lockdown regime. Creditors and debtors having access to the IBC proceeding is essential in expediting India”s recovery post the coronavirus pandemic. Of course, public policy must address the issues of a sudden drop in aggregate demand, unemployment, broken supply chains, but even temporarily halting the redressal mechanism to resolve bankruptcies will be counterproductive to the cause of economic recovery.
The aim always, especially post the pandemic, must be on improving the availability and lowering the cost of credit for productive purposes. The three key operational words are “availability”, “lowering” and “productive”. The primary aim of the IBC mechanism is to build faith in the credit-markets in India.
Greater confidence in the ability of the system to resolve bankruptcies leads to greater willingness of lenders to lend more significant amounts while charging lower risk premiums for credit. Eventually, from a lender”s perspective, the ease of resolving credit issues will encourage them to both lend more and lend at lower rates. It is precisely in stressed credit markets where the credit redressal mechanisms such as the IBC truly deliver value by allowing credit situations to be resolved and the credit to be redeployed into more productive uses in the economy.
Shutting down the IBC risks simultaneously slowing down the flow and increasing the cost of credit, as lenders for future purposes will have to price in the possibility of extreme credit stress resulting in a slowdown or shutdown of the credit resolution mechanism. On the contrary, now is the time for the IBC to deliver results over the next few years as resolving credit related issues to build lender confidence and redeploy the capital in the economy assumes prime importance.
One can use the stock market as a broad analogy to explain the IBC system. At a basic level, the IBC is effectively an exchange where the various players involved agree on a settlement price to resolve a credit issue. In other words, the IBC provides a price and value discovery mechanism to allow for credit issues to be addressed. Similarly, stock markets effectively act as an exchange where buyers and sellers interact to decide on the price of securities. Perhaps the greatest similarity between the IBC and the stock market is that both provide “currency” for the seller and the lender to derive value from the asset or credit they own. A creditor or owner of a share effectively can utilise an exchange to create financial liquidity by selling the asset or transferring the ownership of the credit to release liquidity that they can use for other purposes.
In constrained and volatile financial markets, the ability of an exchange to provide liquidity is a significant driver in the value financial market participants attach to that particular exchange. Simply shutting down the exchange not only has substantial short-term ramifications but has significant long-term implications on the depth and market size that the exchange can command. That constrained credit conditions will lead to increased market volatility is a given. Financial market participants must be aware of these aspects of the financial markets. However, the provision of liquidity in volatile markets is crucial, if not the most important, aspect of mechanisms such as the IBC.
While it is crucial to appreciate just how difficult a business environment the coronavirus induced pandemic has created, and support for businesses and employees is much required, enabling the credit resolution mechanisms is also vital. However, the right tools must be utilised to address each issue.
Issues companies face due to a drop in aggregate demand are, in essence, separate from creditors looking to ensure that their lending portfolio remains robust. While a precipitous drop in aggregate demand will lead to companies struggling to service their debt, the solutions must address the demand issue separately from the credit issue. Otherwise, simply shutting down the credit resolution mechanism will result in kicking the can down the road and problems festering into even larger ones.
As India looks to re-emerge from the lockdown and get its economy back on track, an efficient credit market which has significant credibility with lenders will be vital. The IBC is an essential pillar with which to ensure efficiency in the economic functioning, and therefore it will have a pivotal role to play going forward. Learnings from the current credit markets once built into the IBC will help it further add value to the Indian economy in the years to come.
Source- Outlook India.