India puts a pause on new bankruptcy cases for a year ⁠— and other changes that will cap the rise in bad loans

• Finance Minister Nirmala Sitharaman has hit pause on filing fresh insolvency cases for the next one year.
• The minimum threshold for initiating proceedings has also been increased from ₹1 lakh to ₹1 crore.
• Any debt that arose due to the impact of coronavirus won’t be categorised at ‘default’ under the Insolvency and Bankruptcy Code (IBC).

"Any indebted situation that comes up because of coronavirus will not be considered as ‘default’ and no fresh insolvency proceedings will be initiated for the next one year," Finance Minister Nirmala Sitharaman said while unveiling the fifth and final tranche of reforms to fight the impact of COVID-19 pandemic on the economy.

This means for the defaults that happen in the next few months cannot be called non-performing assets (NPA), simply put a bad loan. “At the moment, I think, the MCA has extended it to six months, we intend to increase it by another six months because even once the lockdown lifts, immediately after, you’re not sure how much of business will be restored,” Sitharaman explained.

A special insolvency framework will be notified under Section 240 A of the Insolvency and Bankruptcy Act. These measures will be enforced via ordinance and then later taken to Parliament for approval.

The total NPA for India’s banking industry is at ₹7.27 lakh crore, the government said on February 2020. There was a fear of a massive spike in bad loans due to the economic crash caused by the pandemic and the lockdown to contain it.

ICICI Securities had expected a 50% jump in gross NPA as nearly ₹2 in every five rupees lent by the banking sector went to “high and medium risk segments”. “We expect credit cost to rise 2.3% and earnings to decline 18%,” the report dated May 13 concluded, ahead of the announcements made by Sitharaman.

The latest decisions will improve the prospects for both banks and non-banking financial institutions. A special insolvency framework will be notified under Section 240 A of the Insolvency and Bankruptcy Act.

Not just big businesses, even small businesses shielded

The minimum threshold to initiate proceedings has been raised from ₹1 lakh to ₹1 crore to insulate MSMEs. “This is a major step forward, and in all probability, we’ll be going through an ordinance to achieve this goal immediately. Of course, we’ll go back to it, once the parliament commences, to have it passed as an act,” she said.

Nearly 10% of all loans made by State Bank of India (SBI), India’s largest bank, are to MSMEs whereas in the case of Axis Bank the proportion is about 7.5%, according to a recent Edelweiss report dated May 13.

The reduced risk of NPAs is likely to boost these stocks when the market opens on Monday, May 18. “However, the responsibility for businesses to use this time to stabilize and improve functioning will squarely be there with onus to put better mechanisms for internal governance as creditors would have to forbear an important right during this period of suspension of IBC for a year,” said Kumar Saurabh Singh, a partner at law firm Khaitan and Co.

Further, the government decision to reduce the number of central government owned companies will also boost the market sentiment. While it is not clear if banks will be part of the notified list of strategic sectors, the Modi government’s existing stance is to merge public-sector banks and to reduce their number.

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