With COVID-19 wreaking havoc on the Indian economy, the government has come up with several measures to provide relief to different sections of society. In a bid to protect borrowers, it launched some initiatives, with a pause in the initiation of proceedings under the Insolvency and Bankruptcy Code (IBC) being one of them.
What is the IBC?
The IBC, which is effectively a recovery mechanism, raises money by taking over a company and auctioning it either as a whole entity or in parts in order to repay creditors of the company. As on 30th June, 2020, out of 3,911 companies which underwent the IBC process, 30 per cent of the cases witnessed creditors successfully realising their money (see the chart below).
The graph 'Comparison of different recovery mechanisms' helps understand how effective the IBC process is as compared to other recovery mechanisms.
Between April 2020 and June 2020, in the midst of the pandemic, the IBC process yielded Rs 8,876 crore, with a recovery rate of 30 per cent, which was still way better than that of any other route. In fact, during 2018-19, the Rs 70,000 crore of debt recovered through this process was almost twice the total amount recovered through all other recovery methods. So undoubtedly, the IBC process is not only the fastest way for realising corporate debts but also the most effective way in terms of the quantum of recovery.
The government's carrots and 'ban' approach
Amid the pandemic, the government took two initiatives to provide relief to debtors. One, it removed the disincentives faced by banks if they chose to give borrowers more time to repay their debts (in the hope that it would spur many lenders to be benevolent). And two, it temporarily cut off access to the most efficient and preferred route for banks to recover their money - the IBC process. Initially, the duration of this temporary suspension was six months till 24th September, 2020. However, now it has been extended by another three months. And in theory, it can be extended by a further period of three months. In that case, the total duration will be one year.
Impact on banks and vendors
It is important to note that the IBC process is currently applicable only to corporate debts. This means that this process is not followed for the recovery of individual debts (unless it is a personal guarantee for a corporate debt). And therefore, there is no such moratorium on the recovery of individual debts through other methods such as SARFAESI, Debt Recovery Tribunals, etc. Further, the relief measure undertaken by the government protects corporates not only from banks but also from vendors who have supplied goods and services to companies but have not yet been paid. These vendors are now prevented from utilising the provisions of the IBC (see the chart below).
How should investors react?
Since the main beneficiaries of this measure are corporate debtors, investors should be wary of the banks which have significant exposure to corporate entities. Even non-financial institutions which operate in the B2B segment could potentially be affected because of the non-payment of dues. Retail-oriented banks and companies operating in the B2C segment are least likely to be affected by this measure. The chart 'Sector-wise break-up of bank loans' gives an idea about aggregate lending patterns. The chart 'Banks with the highest exposure to corporate loans' mentions the most vulnerable banks now.
Investors should look out for any early warning signs which indicate any difficulty in the actual realisation of money. The importance of monitoring the working-capital cycle and cash-flow statements cannot be overemphasised. Unless careful scrutiny as well as diligent analysis is made, the possibility of being blindsided cannot be ruled out.