However, Moody’s also said significant infrastructure constraints have to be crossed for the framework to be fully operational.
On May 11, Indian parliament passed the a national bankruptcy law, the Insolvency and Bankruptcy Code, 2016, which is now pending the President’s signature.
“The current weak legal framework for asset resolution has been a key structural credit weakness for Indian banks,” Srikanth Vadlamani, vice president and senior credit officer at Moody’s.
“The proposed new rules address several key inefficiencies in the current resolution regime,” he said in his report `Banks-India: Bankruptcy Law is Credit Positive for Indian Banks, but Challenges Remain’.
According to the report, the proposed bankruptcy law would; introduce a unified framework to replace the current collection of separate laws drafted in piecemeal fashion across overlapping jurisdictions; reduce threshold for creditors to invoke the insolvency resolution process (IRP); introduce third-party insolvency professionals (IP) as intermediaries to oversee the IRP, replacing the debtor’s existing management and operate the company as a going concern upon initiation of an IRP; give creditors overriding authority to approve terms of any restructuring package; and limit duration of IRP to maximum of 270 days, after which a company will be automatically liquidated.
These features are positive for Indian banks because they will act as an incentive for corporate borrowers to avoid loan default and improve the recovery of assets, the report said.
In addition to increasing banks’ influence over the restructuring process, the mandated replacement of the existing management during the process should act as a key disincentive for debtors to default in the first place.
Moreover, the limited timeframe strengthens the banks’ bargaining power over delinquent borrowers.
According to Moody’s, significant infrastructure constraints have to be overcome before the framework can become fully operational, including; development of the required infrastructure required support new restructuring procedure, particularly legal resources and information utilities; time required for various stakeholders to accumulate the requisite legal experience and precedents for the new system to be fully up and running; and limited impact that the new law may have on the liquidation process.
The proposed law will have limited benefit in addressing the current asset quality issues facing Indian banks.
“In particular, the banks will still have limited avenues available to dispose of distressed assets, and will in general remain reluctant to make appropriate haircuts to reflect their current weak operating conditions,” Moody’s added.