Dr. Renuka Sane*
The Fresh Start (FS) Chapter under the personal insolvency provisions in the Insolvency and Bankruptcy Code, 2016 (Code) has generated a fair bit of controversy. Reports in the media seem to have given the impression that this is a ‘loan waiver’ for all small borrowers. 1 The micro-finance industry has raised concerns that the fresh start provisions will threaten its very existence for fear of en masse defaults by borrowers.2
This article presents provisions of the FS, and provides rough estimates of how many people is it likely to cover, and what implications it may have for credit culture going forward. It suggests that there are about 20-25 million borrowers who may become eligible. It also makes the case that the fresh start process is a more structured form of debt waiver which will force debtors to make the trade-off between a waiver in the present and potentially more expensive credit in the future.
ABOUT FRESH START
The process of FS under Part III of the Code allows for a complete waiver of debts to those who meet certain eligibility conditions. The most important of the eligibility conditions are as follows:
While the Code has left open the possibility that regulations will specify other kinds of debts in the class of excluded debts, current provisions suggest that certain debts cannot be waived of.
FS is possible only for qualifying debts. These include amount due, which includes interest or any other sum due in respect of the amounts owed under any contract, by the debtor for a liquidated sum either immediately or at certain future time. In addition to excluded debts, secured debts and debts incurred three months prior to the date of the application cannot be discharged.
The Insolvency and Bankruptcy Board of India (IBBI) is expected to keep a record of the FS which will be available to creditors making a lending decision in the future. An individual can apply for a FS again after a gap of at least six months between subsequent applications.
These conditions suggest that the FS in not a free-for-all loan waiver process. It is applicable only to certain category of individuals, for certain kinds of debt with records maintained on the use of these provisions.
Coverage of Fresh Start
A natural question to ask is under these eligibility conditions, how many people could possibly be eligible for a fresh start? This is important because even a rough estimate of the numbers makes it possible to get a sense of scale of the possible debt waivers, and for both the lending industry and the government to prepare the processes and institutional machinery for the eventuality of some filings.
While formal and informal debt would get covered under the Code, the ability to enforce a moratorium, as well as deal with a FS, is likely to be limited to formal debt, at least in the short run, till such time the enforcement machinery gets developed to deal with money lenders, or other sources of informal debt. For this reason, the focus on coverage is restricted to sources of formal debt. This largely includes banks and micro-finance institutions. Unfortunately, neither source is able to provide information on income, assets and debt outstanding.
Data: Banking System
Since FS is applicable to outstanding debt below Rs. 35,000, it makes sense to look at the lending of banks where the size of loans is less than Rs. 25,000. While the next size category (between Rs. 25,000 – Rs. 50,0000) will cover some of those with less than Rs. 35,000 of debt, limiting the analysis to the first category is likely to give more precise estimates.
Banks in India had given loans of less than Rs. 25,000 to 36.5 million accounts in 2017-18, with total credit outstanding in this category of Rs. 400 billion. 4 However, not all of this credit is likely to be unsecured credit, and not all of the credit is likely to be given to those with annual income and assets less than Rs. 60,000 and Rs. 20,000 respectively. The income and asset profile of these borrowers is not known.
The same source of data suggests that two kinds of debt are more likely to be unsecured-direct finance to agriculture and credit card debt. These two categories were at 15.9 million (credit outstanding of Rs. 245 billion) and 5.7 million accounts (credit outstanding of Rs. 23 billion) respectively, bringing the total to 21.6 million accounts. The remainder of the 15 million accounts in the less than Rs. 25,000 category may or may not be unsecured credit. If 10 per cent of these are unsecured credit, there would at least be 23.5 million accounts in the banking system that could become eligible for FS.
Industry reports suggest that as of 2017-18, there were a total of 35 million clients of Micro Finance Institutions (MFIs), with a gross outstanding portfolio of Rs. 688 billion.5 The average loan per borrower was about Rs. 14,700 suggesting that a large proportion of MFI borrowers may become eligible for a FS under the debt criteria. It is extremely difficult to assess the income and assets of this set of individuals, and a Below Poverty Line (BPL) card may be a useful proxy. According to industry reports, 65 per cent of micro-finance clients have a BPL card. The other condition for eligibility is that the borrower should not be a home-owner. Since 96 per cent of MFI clients are women, it is likely that they are not primary home-owners and therefore eligible for the FS process. This suggests that about 23 million MFI borrowers (those with BPL cards) are likely to become eligible for FS. Here again, the actual number may depend on the outstanding debt of these households, and it is quite possible that several of them have debt outstanding greater than Rs. 35,000 (since we only have an average estimate of Rs.14,700).
Data: Household Surveys
Banking sector plus micro-finance gives us a total of about 46 million accounts. Since these are accounts and not individuals, they may not be unique. That is, it is possible that the same individual has multiple accounts across banks, and micro-finance. In addition, many of these individuals may actually get disqualified on the basis of their income and assets.
Household surveys can provide a comprehensive picture of an individual’s portfolio. Unfortunately, there is no one nationally representative household survey in India that gives us all three metrics. The National Sample Survey Office All India Debt and Investment Survey (AIDIS) is not able to provide details on income, and is also dated – the last available release is as of 2012-13. Other surveys, such as the National Bank for Agriculture and Rural Development (NABARD) All India Financial Inclusion Survey (NAFIS) do not provide a comprehensive picture at both the urban and rural levels.6
The AIDIS data suggests that the average cash dues outstanding per household was Rs. 32,522 and Rs. 84,625 respectively for the rural and urban areas, higher than the FS threshold of Rs. 35,000.7 There is, however, a huge variation depending on how asset-rich the household is. The average value of outstanding debt is lower than Rs. 35,000 for the bottom seven deciles (by asset holding) in rural areas and five deciles (by asset holding) in urban areas. However, the average value of assets of even the lowest decile in rural India was about Rs. 25,071 higher than the Rs. 20,000 limit set under the FS, while that of the first two deciles in urban India was under the Rs. 20,000 FS limit.8 This suggests that at most the bottom two deciles of households in India will be eligible for the FS.
India has about 252 million households. The bottom two deciles would constitute about 50 million households. If about 46 per cent of households are indebted9 then this brings us to about 23 million households. If, however, the incidence of indebtedness is 20 per cent, then the number of households is 10 million.10
Estimates of Coverage
The numbers from the banking and micro-finance industries point towards approximately 23 million accounts being eligible for a FS. If these are exclusive of each other than one can expect about 46 million accounts that might be eligible. If each individual holds at least two accounts, then we have about 23 million individuals who might become eligible for a fresh start on the basis of the debt outstanding. The AIDIS survey suggests that between 10-23 million households might be eligible depending on the actual incidence of indebtedness. The coverage, therefore, through a very rough estimate is likely to be around 10-25 million borrowers.11This may be an overestimate if either of the thresholds bind, or if the same households have multiple borrowings. The actual update of the FS will obviously be lower than this number.
LOAN WAIVERS VS. FRESH START
Even though the FS will not cover every individual debtor, there remain concerns that these thresholds will have an adverse impact on the credit industry. First, it is argued that if individuals are allowed to get a debt waiver, then it may create moral hazard and destroy credit culture. Second, some believe that local politicians may incite individuals to default using the provisions of the Code, as was done after demonetisation, and this may wipe-off the micro-finance industry. The formal sector may become reluctant to lend, increasing the cost of credit, pushing individuals further to the informal sources of credit.
It is important to remember that a politically declared loan waiver is not the same as a FS. The decision to apply for a waiver is that of the individual, and each instance of availing of the FS will be recorded at IBBI. As a result, the individual is forced to evaluate the trade-off between a waiver of debts in the present vs. potentially higher cost of credit in the future. This is likely to act as a check against abuse of these provisions, as the waivers are not ‘free’.
The existence of FS would make it possible to implement the waivers through a more structured process, and also ensure that the benefits actually reach the intended recipients, which cannot be said of loan waivers implemented earlier.12 The FS would now be available at any point in time, and one can hope that the political gains from declaring something that is available by law are lower. Finally, the waiver of debts might actually make the borrowers more creditworthy as their balance sheets will now be clean. For a lender, the process of going through resolution of this debt is likely to be more expensive than the write-off from a waiver.
In conclusion, the FS provisions of the Code will apply to a small subset of the most vulnerable borrowers. While preliminary estimates suggest that these would be in the range of about 20-25 million households, this may be an overestimate if either of the thresholds bind, or if the same households have multiple borrowings. Not all of these households will be in distress and have reason to file. There is evidence from across the world that many people who are qualified and would benefit financially from getting bankruptcy relief, fail to do so, for various reasons such as lack of information, access, stigma. These factors are also likely to be present in India as well.
The actual number of filers is almost certainly going to be far less than the number of people who are eligible.
The FS will provide them with a dignified means of availing a waiver, without having to resort to a politically motivated process that destroys credit culture. There may be an initial overreaction by industry until they get a sense of how many actual filers there are, but it should stabilise over time. The implementation of the process is not going to be without its set of challenges.13 If done well, then it might prove to be an effective means of providing relief to distressed borrowers.
* The author thanks Mr. Dwijaraj Bhattacharya from Dvara Research for useful conversations.
1Karunjit Singh and Deepshikha Sikarwar (May 13, 2019), Universal debt relief scheme on cards for small borrowers, The Economic Times.
2 Tamal Bandyopadhyay (June 23, 2019), A new challenge for the micro-finance industry?, The Business Standard.
3 Section 79 (15) of the Code.
4 Outstanding Credit of Scheduled Commercial Banks : Size of Credit. Less than 25,000. CMIE Economic Outlook and Basic Statistical Returns of Scheduled Commercial Banks in India. Reserve Bank of India.
5 Sa-dhan. The Bharat Micro-Finance Report, 2018.
6 NAFIS was launched in 2016-17 as a national level survey to provide an overview of the rural population in terms of their status of livelihoods and level of financial inclusion.
7 Key Indicators of Debt and Investment in India, NSSO 70th Round, January – December 2013, Statement 3.15, pp. 28.
8 Key Indicators of Debt and Investment in India, NSSO 70th Round, January – December 2013, Statement 3.2, pp. 11.
9 Subhamoy Chakraborty and Renuka Sane (2019), Household Debt in India, The Leap Blog. ; Also see the NAFIS 2016-17.
10 Key Indicators of Debt and Investment in India, NSSO 70th round, January – December 2013, Statement 3.4, pp. 19.
11 This assumes about one borrower per household.
12 Renuka Sane and Amey Sapre (2017). Implementing loan waivers: Lessons from the 2008 All India Debt Waiver Scheme experience.
The Leap Blog. https: blog.theleapjournal.org
13 Renuka Sane (2018). Loan waivers as fresh start in bankruptcy. The Leap Blog. https://blog.theleapiournal.org
*(Dr. Renuka Sane is an Associate Professor at the National Institute of Public Finance and Policy.)