Sunday, 27 November, 2022
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Financial bailouts must be for struggling businesses to preserve jobs, not repay old debts

The Indian govt & the RBI launched many schemes to ensure availability of credit during Covid, but financial institutions are still cautious about new lending.

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Around the world, governments are struggling to mitigate the impact of Covid-19 on economies, with many announcing relief packages for businesses facing revenue losses and cash flow disruptions. India, too, has announced a host of measures over the last few months, including those targeted at improving the availability of credit in the economy.

However, anecdotal evidence indicates that banks and financial institutions continue to be cautious about new lending, while the fundraising challenges of businesses, especially smaller ones, are getting exacerbated with every passing day. This is not inexplicable. Given the downside risks, financial institutions entrusted with ensuring liquidity under the current circumstances have a limited risk appetite, and understandably so.

An unfolding crisis

Soon after the Covid-19 lockdown was imposed in March, the Reserve Bank of India (RBI) announced a loan moratorium scheme that allowed debtors to avail a temporary suspension of their repayment obligations to banks and other financial institutions. As per the RBI’s most recent financial stability report, nearly half the customers of financial institutions it regulates (including corporates) had availed this protection as of 30 April 2020. Given the scale of this suspension, extending the moratorium indefinitely may lead to solvency issues at many financial institutions, potentially undermining the stability of the entire financial system.

On the other hand, if the moratorium is lifted anytime soon, a large number of businesses are likely to come under severe financial distress. As such businesses struggle for survival, many will have to let go of employees, impose hiring-freezes and cut salaries. This, in turn, will affect consumer spending, depress demand, and lead to economic disruptions in several sectors. This vicious cycle has already started to play out. The Narendra Modi government recently suspended the operation of the Insolvency and Bankruptcy Code (IBC) for loan defaults attributable to the Covid-19 crisis. While this might help in preventing the liquidation of some viable businesses in the short term, it will not be enough to help them tide over the crisis.

Even if some businesses do receive new financing, unless such money is utilised for working capital needs and to preserve jobs (and not used up entirely to repay past debts), it will only create a debt overhang with no real benefits to the economy in the near future. In our most recent briefing book, published earlier this month, we make a case for designing a temporary statutory system for providing liquidity support to viable businesses during the crisis, and ensuring that the amounts raised are utilised for saving jobs and reviving the economy.

Also read: India needs a financial crisis agency to handle impact of Covid and future disasters

A plausible response

The proposed framework should be seen as a protection window for the economy in general, and not as an insolvency resolution tool for specific businesses.

The key elements of the protection window should include: (a) allowing only debtors (and not creditors) to initiate the proceedings; (b) providing an automatic, but qualified, moratorium on debt enforcement for a specified period, as notified by the government, depending on the state of the economy; (c) allowing the existing management to remain in control; (d) providing super-priority for all new financing availed during the protection period; (e) preventing termination of employee and vendor contracts (especially for small businesses) beyond a specified threshold; and most importantly (f) outlining definite exit alternatives for the debtor, linked to its financial position when the moratorium is eventually lifted. Such outcomes may include debt restructuring outside formal proceedings, resolution or liquidation under the IBC, or resumption of regular debt repayments, as the case may be.

Also read: Rethink role of crisis cartels, as Indian industries face risk of overcapacity

Safeguards for balanced outcomes

In order to ensure that the process is not abused, debtors filing for protection under this mechanism should fulfil well-defined eligibility criteria. This may range from financial parameters specific to the debtor, sectoral considerations, strategic importance of the business for the economy, etc. Additionally, the mechanism should also have a monitoring or reporting system, to ensure that it is used for preserving viable businesses, and not for evergreening of loans or siphoning off of funds.

The administrative authority-in-charge of implementing the framework should include representatives from sectoral regulators, the industry and the lending community, to ensure balanced outcomes. It may be rolled out in phases, starting with sectors that are the most distressed. Finally, the entire scheme should be backstopped appropriately with a funding scheme for the financial institutions affected by the moratorium.

Debtors that were under financial distress before the Covid-19 crisis started, or those under severe distress, should be kept out of this scheme. Insolvency situations involving such businesses would be better resolved under the regular insolvency process, or a quick out-of-court mechanism like ‘pre-packs’. Any delay in resolving them will only deepen the intractability of their problems, and cause greater losses to the stakeholders. The Modi government could consider expanding the scope of ‘interim finance’ (as defined under the IBC), to encourage rescue financing of such debtors during regular insolvency proceedings.

If designed and executed properly, the measures outlined above can go a long way in ensuring adequate liquidity in the Indian economy, avoiding a debt overhang, and preventing large-scale job losses without undermining the financial system.

Towards a Post-Covid India is a briefing book with 25 legal reforms recommended by the Vidhi Centre for Legal Policy. Join a series of conversations — ‘Law with a Difference’ — on the book. ThePrint is the digital partner. Read all the articles here.

The author is the Co-founder, Vidhi Centre for Legal Policy (with inputs from Anjali Anchayil). Views are Personal.

Also read: Mega projects can reignite economy but infra NPAs for banks remains high, says RBI governor


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