Much has been written about the nonperforming asset (NPA) crisis plaguing the Indian banking system. The Insolvency and Bankruptcy Code (IBC) has been widely hailed as the silver bullet. But it has arguably done more to systematically ‘destroy value’ in the economy than any other legislation in the past.

A‘haircut’ is so much more than just what the banker is willing to part with, in lieu of the immediate settlement of the account. It represents the ‘necessary destruction of value’ in an economy.

Based on the latest data released by the Insolvency and Bankruptcy Board of India (IBC), the Centre for Financial Accountability calculates that the creditors of companies having total claims of more than Rs 500 crore have had to take an average of 44% ‘haircut’. This comes to a combined real loss (write-off) of about Rs 38,000 crore ($5.2 billion) under the corporate insolvency resolution process.

This begs the question of what necessitated this constructive destruction of value in the first place. Some answers include the indiscriminate lending by banks to corporates during what finance minister Arun Jaitley would like to call the “lending regime without accountability”, and the overweening influence of the new Bollygarch.

Jaitley further claims that during this period, the banking sector’s outstanding loans — especially those of the public sector banks (PSBs) — rose from Rs18 lakh crore in March 2008 to a whopping Rs52 lakh crore in March 2014.

Whatever may be the precise causes of the crisis, the mere scale of the problem should lead one to think about the possible impact — or, the pain —the cleaning-up of this mess could inflict on the broader economy.

In his book, The Great Crash 1929, John Kenneth Galbraith, wrote, “To the economist, embezzlement is the most interesting of crimes. Alone among the various forms of larceny, it has a time parameter. Weeks, months or years may elapse between the commission of the crime and its discovery.

(This is a period, incidentally, when the embezzler has his gain and the man who has been embezzled, oddly enough, feels no loss. There is a net increase in psychic wealth.) At any given time, there exists an inventory of undiscovered embezzlement in —or, more precisely, not in — the country’s business and banks.

This inventory — it should, perhaps, be called the bezzle — amounts at any moment to many millions of dollars.” Inescapably, the haircut that creditors are forced to take under IBC fits exactly Galbraith’s description of the ‘bezzle’.

The hitherto undiscovered bezzle is now being systematically discovered and written-off under the resolution process. It has acquired, in some sense, a certain legitimacy in light of the ‘greater good’ that happens in its name.

The value created above and beyond what was deserved and rational should necessarily be destroyed at any rate, to maintain sustainable levels of credit and confidence in the economy.

But who is most affected in this whole process of legalising the bezzle? The most immediate hit, of course, is taken by the banks, who lent the money in the first place.

But how this bezzle gets diffused across the broader financial system and whether it is going to have any tangible impact remain to be seen. It would be hard not to conjecture that the banks in the end would be forced to pass this bezzle on to their customers, in some form or the other.

In its two-year career, IBC has worked roughly well towards producing broadly favourable outcomes for creditors as specified under the code. ‘Recoveries’ are said to be the principal object of IBC. But the enormous collateral damage that its implementation in its current form necessarily entails — and its implications on the broader economy — must be taken more seriously.

The article, first published by the Economic Times, can be accessed here.

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