Bankruptcy law: State - 1; market - 0

The successful implementation of the new Act will depend on a much bigger involvement of the state through a huge new superstructure of registration, certification and supervision, says Debashis Basu.

The government has just passed a new law to deal with bankruptcy. In February, I wrote in this column that that this Bill would not evoke much opposition among Congress and other parties "because they would perhaps have no vested interests to defend, or issues to capitalise on just now. Bankruptcy is arcane stuff for them. Hopefully the Bill will get passed."

The government can now claim this as a clear proof that it is committed to economic reforms and getting important economic legislation passed.

Poor resolution of bankruptcies is a big contributor to India's low position in the World Bank's ranking of Ease of Doing Business. By getting this Act through, a checkbox has been ticked and India will move up in the ranking next year, drawing press releases from the government and headlines in the media.

Businessmen, bankers and economists have already put out obligatory statements of praise. But unfortunately, the new Act unleashes more of what has not worked so far - deeper involvement of the state.

The players in the insolvency business today are: bankers, borrowers, asset reconstruction agencies and of course, girding them, a tangled legal system involving debt recovery tribunals and courts.

This system, which is a product of three decades of patchwork solutions, has turned into a cesspit of seedy deal-making, long inaction, stymied resolutions and tens of thousands of unresolved cases. It has little to do with law and everything to do with the role of the state from the beginning to the end.

It starts with state ownership of banks, where the overwhelming amount of bad business loans originate. Everybody knows how and why so many big loans in public sector banks (PSBs) go bad and why almost everyone gets away with this loot and corruption.

To repeat what I wrote almost two years ago, "no bank chairman and very few bank officers pay any price if banks are found to be horribly short of collateral - a cardinal sin in banking - that happens routinely in our nationalised banks".

Every government has been held to ransom by unions whenever there is even a whiff of ownership change.

Having created bad loans with one arm, the state then comes in to resolve them with another. Cases are referred to Debt Recovery Tribunals, where, away from public scrutiny, public sector banks are raped a second time: this time by lawyers on both sides and opportunistic businessmen picking off assets of a dead business.

The bigger and more high-profile cases never come up. While Vijay Mallya's case is tearing up the vocal chords of television anchors and MPs, do you hear anyone ever talking about the legal status of the top three cases of loan defaults? The system, run by the state, is tuned to let some people off quietly.

Isn't the new bankruptcy law different? In some ways it is worse, if you know how the state's involvement usually makes things worse in India.

The successful implementation of the new Act will depend on a much bigger involvement of the state through a huge new superstructure of registration, certification and supervision. This means more sinecures for bureaucrats and higher costs for those hoping to recover loans.

Coming up is an Insolvency and Bankruptcy Board of India, insolvency professional agencies (IPAs), insolvency professionals (IPs) and information utilities. The Board will regulate IPAs, which will in turn regulate IPs by conducting examinations to certify and enrol them, and enforcing a code of conduct.

The IPs will be responsible for carrying out the resolution process and managing the company. Then comes an adjudication process by two agencies: National Company Law Tribunal (NCLT) under Companies Act, 2013 and Debt Recovery Tribunals (DRT). NCLT has not yet been set up, and DRTs are groaning under pending cases.

We have had three statutes so far; each was conceived to solve the bad loans mess without doing anything about the source of the bad loans and the system of handling them.

We have a more detailed law now that creates a huge new bureaucracy (more agencies and more "professional work") that will slow down and compromise decision-making at all levels. We are told it will work. But doing the same thing over and over again and expecting different results is the definition of insanity, according to Albert Einstein.

If we start to think of market-based solutions, we will start cutting down on both the origination of bad loans and the need for a bureaucratic monster to process them even less efficiently.

This simply involves two steps: one, making bankers accountable for their decisions through carrots and sticks; and two, creating a thriving distressed debt market where bad loans can be traded, with easy participation by institutional investors, banks and businessmen.

This would require some tinkering with various Acts that govern financial property rights. But the bigger thing it would require is a philosophical change: when it comes to commercial matters, trying to find solutions in markets rather than in state machinery.

Debashis Basu is the editor of www.moneylife.in