Renuka Sane: Caring about personal insolvency

The problem of large-scale non-performing assets, or NPAs, in the banking sector is at the forefront of the policy debate. Kingfisher Airlines has been in the headlines, as has been the Supreme Court's request for a list of willful defaulters. There is hope that the proposed Indian Bankruptcy Code (IBC) will solve some of these problems, and prevent such a build-up of NPAs in future owing to timely resolution of insolvency. All of these discussions have been about resolving corporate insolvency.

However, three important facts need to be borne in mind. First, agriculture constitutes a large part of total bank credit. Lending to agriculture increased between 2014 and 2015 by about seven per cent. There is concern building up that a large proportion of the subsidised loans given to farmers through Kisan Credit Cards have gone bad. Second, in 2014-15 personal loans saw a growth of 12.5 per cent. This includes 21 per cent growth in housing loans and 22 per cent growth in credit card lending. Third, a large number of corporate loans require a personal guarantee. If the limited liability firm defaults on its repayments, banks can invoke this personal guarantee, after which the liability falls on the individual guarantor. In all of these cases, the debtor is the individual. If these loans go bad, as some of them undoubtedly will, collective action against a defaulting debtor will not be able to go through the corporate insolvency route. Here, creditors will have to rely on the provisions regarding individual insolvency.

The current system for resolving individual insolvency is broken. The Presidency Towns Insolvency Act, 1909 (PTIA) and the Provincial Insolvency Act, 1920 (PIA) have not caught up with changing times, and delays in courts have meant that these provisions get used very rarely. The problems of Debt Recovery Tribunals (DRTs) make recovery action against individuals through the SARFAESI route as cumbersome as against a corporation. The inability to recover loans through legal systems has led to several incidents of recovery through musclemen, leading the Reserve Bank of India to issue circulars against coercive collection. Distress on farm loans and suicides by farmers have led governments to announce debt waivers. While they may or not provide relief to farmers, they contribute towards worsening the debt culture, which is bad news for banks.

It is against this background that the personal insolvency provisions - for both natural persons as well as sole proprietorships and partnerships - in the proposed Indian Bankruptcy Code assume importance. There are two mechanisms, similar to that of corporate insolvency, except that the personal insolvency proceedings will be heard at the DRTs, while the corporate ones will be at the National Company Law Tribunal (NCLT).

The first is the Insolvency Resolution Process (IRP) which lays down the framework for negotiations between an individual debtor and her creditors that help to arrive at a restructured repayment plan. On the trigger of an IRP, there will be a moratorium on collection for six months. Debtors and creditors would be required to agree on a repayment plan within this moratorium period under the supervision of a resolution professional. Once approved by the creditors and sanctioned by the adjudicating authority, the plan would be binding on the debtor and all the creditors mentioned in the plan.

The second is the Bankruptcy Process (BP) which can be triggered only if the IRP has failed. The adjudicating authority will pass a bankruptcy order declaring the debtor a "bankrupt", and vest the estate of the bankrupt with a resolution professional. The estate will be distributed among all the creditors according to the priority described in the proposed law.

In the case of insolvency due to the trigger of the personal guarantee in an on-going corporate insolvency, the same process of IRP for individuals will apply to the personal guarantor. These proceedings will be held in the NCLT, the forum for corporate insolvency, and not the DRTs.

For the poor, it is possible that the costs of an IRP far outweigh the debt at stake. If the poor, and especially poor farmers, are struggling to repay debts, it is politically tempting for governments to announce loan-waivers. These have the potential to throw banks off guard, and also destroy the credit culture. The draft IBC, therefore, proposes a third mechanism of a "fresh start" process, wherein low-income and low-asset households will be able to apply for a formal debt-waiver. Under this process, certain debts will be officially waived, allowing the debtor to truly make a "fresh start". Governments could also route loan waivers through the fresh start mechanism. This is likely to bring some predictability around the granting of loan waivers.

The draft IBC is the first attempt at a comprehensive law governing individual insolvency. For individual insolvency provisions to work, we will require an ecosystem of resolution professionals, information utilities that help identify a default, and courts that are able to expedite processes. When the code is implemented, and when the institutional infrastructure falls into place, we could see a huge change in the working of the market for individual credit. This is something banks, and other lenders to individuals, need to focus on.

The writer is at Indian Statistical Institute, Delhi Centre

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