Bankruptcy Code: Banks to gain, but not immediately

Bankruptcy Code will consolidate existing laws related to liquidation and sick industries

Bankruptcy Code, 2016 regarded as the most critical regulatory change for the ease of doing business in India and a move that will strengthen the loan recovery process, was passed by the Rajya Sabha on Wednesday.

The news pushed up bank stocks, taking the Nifty Bank and PSU Bank higher by about a per cent each. But, investors need not hurry to buy bank stocks, as the Bill is unlikely to improve the asset quality of banks materially in the near term.

First on the positives, the Bankruptcy Code will consolidate the existing laws related to liquidation and sick industries and create a new institutional consisting of insolvency professionals (IP), IP agencies, information utilities and a bankruptcy board to resolve insolvency.

More importantly and first of its kind, the Code has set a time limit of 180 days (extendable by 90 days), within which the resolution has to be completed.

Also, as any financial or operational creditor may initiate the insolvency resolution process, the Code vests more powers with banks to stringently monitor their clients.

The Code will also see professionals engaging with the management of the distressed companies who would in turn be supervised by a regulator. As in the case of the Companies Act, unpaid employees and secured creditors will get priority for pay-out as per the Code in the case of liquidation.

Analysts at Nomura say the Code is a big positive for the banking sector. "As the Code gives banks a legal path for recovering their dues in a time-bound manner, it should make lenders more confident in lending and borrowers more accountable", they elaborate.

While other experts agree with this view, they feel that the time involved in implementing this code could delay the benefits accruing to banks.

"It will take at least a year to create the infrastructure to implement the Bankruptcy Code. Therefore it is unlikely that the benefit of this is felt in the asset quality of banks any time soon", says Pankaj Agarwal of Ambit Capital. Therefore FY17 could also be a year of elevated asset quality pressures as the Code may not benefit banks in the near-term.

Added to the implementation timeframe, analysts at Religare feel that delays may also stem from want of accurate or timely information and inefficient adjudicatory mechanisms.

The research house which remains negative on the banking sector says that it may take three-five years for issues to resolve under the Bankruptcy Code. With these finer aspects to take note of, the Bankruptcy Code for now is more a sentiment booster, though post implementation it could have a significant bearing on the asset quality of banks.

Some, however, also believe that the defaulters or potential defaulters will now think many times before skipping/delaying payments, and that should reflect positively on banks in the form of lower or at least a slowdown in bad loans.

Photograph: Reuters