Bankruptcy law credit positive for banks: Moody's

The new bankruptcy law is credit positive for Indian banks as it increases their bargaining power in distressed asset resolutions, Moody’s Investors Service said today. The current weak legal framework for asset resolution has been a key structural credit weaknesses for Indian banks, it said.

“The new bankruptcy code is credit positive for Indian banks because it will vastly increase their bargaining power vis-a-vis debtors in distressed asset resolutions,” it said.

Moody’s said the new law entails greater efforts by corporate borrowers to avoid default and thereby a possible insolvency resolution process, as such a procedure would cause management to lose control over the company immediately.

“We expect this consequence in itself will act a major incentive to avoid loan default,” Moody’s said.

It said the insolvency resolution process should lead to better asset recovery under the new framework, owing to the greater influence the banks as creditors will have over the resolution outcome.

“In addition, the mandated replacement of the existing management during the restructuring process reduces the risk of asset stripping,” it said.

Finally, the limited timeframe of no more than 270 days strengthens the banks’ bargaining position against the delinquent debtor.

Earlier this month, Parliament approved the Insolvency and Bankruptcy Code, 2016, which will offer a unified framework to replace the current collection of separate laws drafted in piecemeal fashion across overlapping jurisdictions.

“The current system has proven to be extremely cumbersome due to a lack of clarity about the applicable jurisdiction and precedents,” Moody’s said.

These features of the new law are in stark contrast to the existing regime whereby creditors’ efforts to recover assets are often undermined by not only a cumbersome legal process but also adverse reactions from existing management and borrowers, it said.

These hurdles often discourage creditors from using the existing legal avenues for restructuring and this further weakens their position in the event of default.

The key issue and risk would be the development of infrastructure required to support the new restructuring procedure, in particular in terms of legal resources and information utilities.

The potential time lags for various stakeholders to accumulate the requisite legal experience and precedents for the new system to be fully up and running would also be a risk, it said.

The new law will therefore go some way to resolve some of the bad loans in the banks’ corporate loan books, but will not address other key challenges faced by the banks, it said.

“The banks still have limited venues available to dispose of distressed assets, and overall remain reluctant to make appropriate haircuts to reflect the current weak operating conditions. These issues are beyond the ambit of the bankruptcy code,” Moody’s added.