Defaults are Costly: Bankruptcy Law Gives Lenders More Teeth

Lenders can bargain strongly on asset recovery, defaulting borrowers can lose control of co

With the Bankruptcy Act in place, banks can breathe easy, at least in the medium term, as corporate borrowers will now intensify their efforts to avoid loan defaults and the likely loss of management control of business, said Moody's Investors Service.

This will empower lenders to bargain strongly in matters of asset recovery, while borrowers can gain with lower borrowing costs after three-four quarters.

“The (defaulting) borrowers will lose control of the company as soon as the process is initiated,“ Srikanth Vadlamani, vicepresident, Financial Institutions Group, Moody's Investors Service, told ET from Singapore.“This, in itself, should act as a key incentive for them not to default in the first place.“

A few weeks ago, the government passed the Bankruptcy Bill, introducing a time-bound settlement process against loan default. With the Bankruptcy Act, the resolution process-from the date of filing cases to the final resolution--will take a maximum of 270 days, with three-fourth of the total lenders agreeing to drag a defaulting borrower to court. In India, it takes 4.3 years to resolve such cases, data from World Bank shows, compared with six months in Japan, eight months in Singapore and 1.5 years in the US.

The new bankruptcy code is credit positive for Indian banks because it will vastly increase their bargaining power vis-à-vis debtors in distressed asset resolutions, Moody's stated in the note.

Borrowers too can gain from it, subject to proper implementation mechanism, and if they are disciplined to repay dues.

“If properly done (implementation), it should definitely lead to a decline in credit cost over the medium term,“ Vadlamani said.

He, however, warned that the Bankruptcy Act is unlikely to be a banking panacea immediately, and everything may not be a cakewalk.

The Economic Times New Delhi, 27th May 2016