COVID-debt clause may worsen NPA mess

Central government has said that insolvency proceedings against fresh defaulters would remain suspended for up to one year and Covid-19-related debt would be excluded from the definition of default. This step however, will potentially hit financial and operational creditors hard and bleed their balance sheet, apart from temporarily depriving them of a credible mode of bad debt resolution. Lenders may be forced to seek regulatory forbearance on provisioning and capital requirements.

Initially, proceedings under the Insolvency and Bankruptcy Code (IBC) can’t be invoked for six months, which can then be extended by another six months, depending on the pandemic situation. There will be a special insolvency framework under section 240-A of the IBC. Already, in a bid to insulate small businesses from being dragged to the NCLT, the default threshold for triggering insolvency has recently been raised to Rs 1 crore from just Rs 1 lakh earlier.

Finance minister Nirmala Sitharaman said an ordinance will be promulgated soon to implement the proposed changes. However, proceedings in the cases already admitted will remain unaffected by the latest move. Data available with the IBBI show, proceedings in 1,961 cases were going on as of December 2019.

Despite risks of a sharp deterioration in credit quality of banks and cash flows of operational creditors due to the suspension of IBC initiation, many experts believe that given the unprecedented crisis, the existence of companies must take precedence over the resolution of stressed assets.

The suspension on fresh initiation of insolvency proceedings for one year is likely to increase provisioning for banks.

“The advantage we were getting to refer a case to the National Company Law Tribunal (NCLT) was reversal of additional provisioning, now that option will not be there,” an MD & CEO of a bank who did not wish to be named told.

According to the June 7, 2019, circular of the Reserve Bank of India (RBI), banks can reverse 20% provisioning for unresolved cases, after referring a case to the NCLT.

“NCLT was anyway the last option for us, so now will try to resolve cases outside court through inter-creditor agreement (ICA) as much as possible,” another senior official told.

Casting the IBC as a landmark law, the government asserted that just the threat of the legislation has ensured recovery of as much as Rs 5 lakh crore up to February 29 since its inception in 2016.

The figure was arrived at by aggregating the default involved in as many as 13,556 cases where insolvency applications were withdrawn from the NCLT before they were admitted, as defaulting promoters rushed to settle dues for fears of losing their companies once the proceedings started.

In the 221 cases resolved so far via IBC, about Rs 1.84 lakh crore was recovered, against the admitted claims of Rs 4.13 lakh crore, marking a recovery rate of 44%, Sitharaman said.