The performance of the Insolvency and Bankruptcy Code (IBC) – a landmark reform implemented during the first term of the Narendra Modi government – has come under scrutiny. The Code has mainly been criticized on three points: firstly, there are excessive delays in the resolution procedure, secondly, there have been more liquidations than resolutions and, thirdly, the amounts recovered under the IBC are not substantial, making it more of a talking point than effective structural reform.
In this article, we focus on the first of the aforementioned critiques to assess the performance of the IBC vis-à-vis the Industrial and Financial Reconstruction Board (BIFR) regime. We argue that evaluating IBC based solely on the average time to resolve successful cases significantly undermines the effectiveness of IBC compared to previous regimes. A common measure used to assess the effectiveness of the IBC is the time taken to resolve cases. It is calculated by taking a simple average of the time taken on each completed case. This is one of the metrics used by the Insolvency and Bankruptcy Board of India (IBBI) to compare the IBC scheme with the earlier BIFR scheme. For example, BAC is often reported to have reduced the average time to settle a bankruptcy case from 5.8 years to 1.6 years. However, the performance of a bankruptcy resolution should ideally be assessed along at least three dimensions: the average time taken to resolve a case, the fraction of cases resolved within a given time frame, and the recovery rate conditional on resolution. Focusing on a single parameter may result in a gross under (over) estimation of IBC performance (BIFR).
We start by looking at the fraction of cases that are resolved within a specific timeframe. For this purpose, we use a simple metric often used in statistics. We first calculate the total number of resolved cases under the IBC (and correspondingly with the BIFR). Then, for any time t (in, say, months), we calculate the fraction of cases that were resolved in less than t months. The figure plots the same for IBC and BIFR.
The fact that the IBC curve (in blue) is significantly higher than the BIFR curve (in orange) over the entire time series indicates that for any fraction of the total number of cases resolved under each program , the IBC took considerably less time than the BIFR. As can be seen, even of the cases that were eventually resolved under BIFR, more than 80% of them took longer than 34 months. In fact, the figure looks qualitatively similar even if we limit the focus to BIFR cases that were resolved within 34 months, as is the case for IBC.
There are two reasons why one might question the above conclusion. First, it may be that while BIFR has been somewhat slow to resolve, it has resolved many more cases. However, this is simply not true. Since its inception in 1987, BIFR has resolved less than 3,500 cases while IBC, since its launch in 2016, has resolved approximately 1,178 cases until it was suspended at the onset of the COVID pandemic. A second criticism could be that this metric tips the scales in favor of the IBC because it ignores the number of open cases. For example, let’s say that, given 10 cases to resolve, IBC resolves one case in one month and nothing more, while BIFR has resolved 10 cases, with each case taking two months. Even in such a case, the graph will look the same. To correct the above bias consisting in considering only settled cases and ignoring pending cases, we propose to use an alternative metric that combines the resolution time horizon and the number of pending cases.
This method is similar to a survival analysis. Specifically, we calculate the ratio of cases settled in one year to cases that spent a year in the bankruptcy system but remained unresolved (this is called the odds ratio). Applying the above metric, we find that in the first year, IBC was nearly 60 times more effective than BIFR. The ratio is 0.0047 for the BIFR, while it is 0.28 for the IBC. Although we focus on a one-year time frame, the method also lends itself to estimation at a higher frequency.
We start with a broad definition of case resolutions that includes both liquidation and sales on a going concern basis. Recognizing the difference between the two, we refine the definition of closing by excluding liquidations from the numerator, while including it in the denominator. The outperformance of the IBC in one year increases significantly. We find that IBC continues to outperform the previous BIFR regime by 66 times, which is significantly better than a comparison based on simple time averages.
We then look at the second year. Here, the denominator consists of cases that have remained unresolved for at least two years, and the numerator is formed by cases that are resolved between the first and second year. The ratios for the IBC and BIFR turn out to be 0.3 and 0.0344 respectively – a significant outperformance of almost 10 times. When we narrow the definition of resolution and exclude liquidation events, the outperformance is multiplied by 28 in the second year. IBC continues to outperform BIFR even in year three, but we stop the analysis here because the period coincides with the onset of the pandemic for many IBC companies. Although the IBC process has continued for existing cases, it is not reasonable to draw an inference based on performance during an extraordinary period such as the Covid-induced crisis.
Finally, since many unresolved cases stuck in BIFR have been transferred to the IBC, delays in resolution must be compared to the history of pending cases. Adjusting the denominator for old BIFR cases – that is, unresolved cases transferred into IBC from BIFR – we find that IBC is at least 23 times more effective than the BIFR regime which l preceded based on year one odds ratios.
It could be argued that because the IBC is more efficient, it is also likely to have seen more cases admitted than under the BIFR. This is a valid point, but only reinforces our thesis that the IBC represents a structural change and a substantial improvement over the BIFR.
The bottom line is simple: IBC far surpassed the earlier BIFR regime in terms of solving speed. Most analyzes of IBC’s performance overlook the important fact that many cases of legacy BIFR were subsumed by IBC, and these were often zombie companies that were kept alive due to mass rollover of loans between 2008 and 2015 – a “mysterious” sequence of events that is destroying India’s banking system that has taken the better part of a decade to repair. Furthermore, the most powerful impact of the IBC is probably its ex ante impact on the behavior of firms and promoters. In other words, the IBC is potentially as effective as a disciplinary device as it is a resolution mechanism.
This column first appeared in the print edition of April 22, 2022 under the title “A high resolution tool”. Alok and Tantri are at the Indian School of Business, Hyderabad; Kuvalekar is with the University of Essex; Mantri is part of the India Enterprise Council. They thank Aditya Murlidharan of the Center For Analytical Finance, Indian School of Business for his research support