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India pushes for inclusive insolvency law

Government aims to extend process to small businesses and individuals

Traders in Srinagar protest against implementation of the Goods and Services Tax (GST) in Jammu and Kashmir state, on July 1, 2017. REUTERS/Danish Ismail   © AP

MUMBAI -- India's plan to beef up its insolvency and bankrupcty law to tackle mounting bad debts has won initial praise from analysts.

The government invited public comment earlier this week on draft rules extending the insolvency resolution processes to individuals and small companies. The Insolvency and Bankruptcy Code introduced in late 2016 currently only covers corporate defaults.

The so-called micro, small, and medium enterprises sector (MSME) has witnessed a sharp rise in non-performing assets in recent years. Finance Ministry data showed that gross non-performing assets in the MSME sector almost doubled to 1.23 trillion rupees ($18.48 billion) in 2016, giving an NPA ratio of 8.77%.

That number is well above the country's average ratio of roughly 2.7%. Estimated total bad loans rose to a record 8 trillion rupees at end-June.

The latest efforts to expand the coverage of insolvency and bankruptcy legislation suggest that the government is bracing for a further increase in non-performing loans related to individuals and small companies.

India is estimated to have around 51 million small and medium-scale businesses. According to newspaper Hindu Businessline, this sector accounts for around 45% of total bad loans.

Ratings agency CRISIL Ratings said: "Loans to MSME, [loans for the purchase of] vehicles and the loan-against-property segment could see some asset quality challenges in the near term because of demonetization and the need to conform business processes to the [Goods and Services Tax] regime ... [The] Insolvency and Bankruptcy Code (IBC) route, and other structuring schemes, will be critical to improving the asset quality of banks."

Lenders are themselves trying to address the issue. India's largest lender, State Bank of India, has created a special division for recovery of non-performing loans and the resolution of stressed assets, under its new chairman Rajnish Kumar, who was appointed on Oct. 4. The bank has also seen mounting bad loans from smaller businesses. At the end of the June quarter, of the 1.88 trillion rupees in bad loans reported by the bank, 12% was from the SME segment.

Krishnan Sitaraman, senior director of CRISIL Ratings, said that extending the legislation to smaller businesses would make it very inclusive and complete, covering all kind of entities. "So, if there is a smaller entity company and it feels that it cannot continue business in a sustainable manner they can take refuge under the legislation and the business can be wound up quickly."

Kalpesh Mehta, partner at Deloitte Haskins & Sells, said individual insolvency would allow small businesses, and individuals, to come out of the debt trap through the Fresh Start debt write-off scheme, and lenders will be able to pursue personal guarantees in a time-bound manner.

According to a Deloitte report, India's debt recovery rate of 25.7% is much lower than that of other countries. The time taken to resolving insolvency or bad debts in India -- around 4.3 years -- is also much higher compared to established markets.

The current bankruptcy law is seen as helping to resolve the problem of delays. Banks can now use the National Company Law Tribunal to seek resolution against non-performing loan accounts, and if the resolution fails to reach an end in 270 days, the insolvency process can be initiated. Banks and other stakeholders can then mutually share the proceeds from the liquidation.

Extending this transparent framework to small businesses will be a key for India to keep the economy rolling.

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