By Dwijaraj B, Dvara Research
As part of the Dvara Research Working Paper series we are publishing our latest paper titled “Estimating Eligibility for the Fresh Start Mechanism under IBC, 2016“.
The Insolvency and Bankruptcy Code (IBC) is a landmark piece of legislation in India. Presently the code is in effect only for corporate debtors and personal guarantors for such debtors (and their creditors). Although Part III of the IBC lists out detailed remedies for natural persons (as well as proprietorship and partnership firms), these are yet to be notified. In the case of natural persons, the code provides a unique remedy, the Fresh Start (FS) Process. Akin to the remedy in the United Kingdom, the Debt Relief Order, this process resembles a bankruptcy process with one major exception. Unlike a bankruptcy process where the debtor’s assets are held in a trust and are then disposed off to repay the lenders, in case of FS, the assets and future income of the debtor are protected. Hence an individual granted a fresh start essentially gets their debt waived without any attachment of assets or impounding of future cash-flows.
This results in a situation where the creditors must write-off the entire balance of the loan account (not exceeding INR 35,000) for all individuals who are granted a discharge under the FS process. As may be expected, this has been a contentious issue since presently there are concerns whether the scale of consumers seeking refuge under the FS provisions will be unsustainable for lenders and the lending ecosystem.
This working paper discusses the FS remedy in detail (including its eligibility criteria, the number of individuals qualifying under it, etc.) and the expected operational hurdles. The bulk of the paper revolves around the estimation of qualifying individuals under the FS process to answer the above question. These estimations are based on secondary data from the All India Debt and Investment Survey (AIDIS 2013), RBI’s annual data from all scheduled commercial banks (SCBs) and a credit bureau data in case of microfinance institutions (MFIs). The analysis uses two parameters, the credit outstanding per account (or client) and the asset ownership pattern of households, to estimate the ceiling of the number of individuals qualifying for FS.
Empirically, it was observed that there has been a shift in the distribution of number of credit accounts with outstanding less than INR 35,000 (the debt ceiling for fresh start) in the last five years, especially for SCBs, and presently only 2.21 million credit accounts of SCBs and 0.79 million clients of MFIs would qualify under the FS criteria of income and debt. The analysis further shows the debt-at-risk (combined exposure of the financial sector that may have to be written off) amounts to INR 59.24 billion. Though these numbers seem significant, reading them in context of the overall exposure of the banking system and the micro-finance sector reveals that when the provisions of FS are notified the credit sector is very likely to withstand its impact.
The full paper containing the estimation methodology, associated literature on the subject and detailed discussion on FS may be accessed here