The reforms could be through low hanging measures which can deliver quick results like enhanced recovery mechanisms or better staffing at judicial level, and through regulatory reforms which require structural improvements in the credit system like ensuring wider participation in Indian Rupee loans for distressed debt funds or strengthening the role of Asset Reconstruction Companies (ARCs), etc.. A combination of these can certainly go a long way in ensuring that the ultimate goals are met.

While the Insolvency and Bankruptcy Code, 2016 (IBC) has been instrumental in addressing the issue of NPAs, the core system requires operational strengthening to achieve quicker and meaningful resolutions. Budget 2025-26 should consider increasing the number of benches in the National Company Law Tribunal (NCLT) and equipping them with adequate operational capacity to expedite case resolutions and prevent backlogs and delays. Adequate training of the judges and monetary recognition for the staff at the NCLT level are crucial steps and it is anticipated that the Budget 2025-26 will provide for these measures in a more transparent manner.

Steps should also be taken to incentivize wider participation in distressed assets, including by empowering ARCs with greater legal authority. This will improve the overall efficiency of the resolution process. Collaborative participation by banks, ARCs, distressed debt funds, other RBI regulated financial institutions and private credit players will create a more competitive and resilient mechanism to address stressed assets effectively.

It is also important to take note of the evolving private credit market, which has recently been the buzzword for Asia in general and India in specific. To ensure that India remains attractive for these players, the regulators would need to incentivize lending by providing a robust mechanism for recovery, information sharing and borrower discipline.

Reflecting on past legislative measures such as the Sick Industrial Companies regime (SICA) and the various Debt Restructuring Frameworks (CDR / SDR / S4A, etc.) underscores the importance of avoiding prolonged litigation and ensuring stakeholder accountability. Long delays and minimal recoveries serves as a cautionary tale as it pays no heed to the time value for money and acts as an antithesis to reform.

While the establishment of the National Asset Reconstruction Company Limited (NARCL) and the India Debt Resolution Company Limited (IDRCL) or “Bad Bank” was a significant step in addressing the NPA crisis, one needs to reflect on this to specifically consider whether there has been true recovery or resolution which aligns with market dynamics especially for NPAs with pure liquidity concerns on account of market conditions, without concerns of mismanagement, etc.

Additionally, RBI can also consider leveraging technology, alternative data and artificial intelligence (AI) tools to strengthen credit risk assessment and enhance asset quality. The Budget should encourage investments and tie ups by banks and financial institutions with advanced data analytics and AI tools to boost risk assessment through NPA management / fraud detection. A centralized database for tracking defaulters and detecting early warning signs by using AI-driven tools / analytics can ensure smarter loan decisions, especially for new-to-credit borrowers and MSMEs. Promoting financial discipline amongst borrowers is another critical aspect and by strengthening the credit information infrastructure and ensuring greater transparency in lending practices, this objective can be met.

Learning from past and avoiding similar inefficiencies will be critical in achieving meaningful reforms. With a holistic approach and commitment to execution, the measures proposed in the Budget can not only reduce NPAs but also set the stage for sustained economic growth and financial stability. As the Indian economy reflects promise for the future, this Budget would indeed be critical as, in addition to the financial institutions like banks, NBFCs, ARCs and AIFs, the global distressed funds and private credit players are also keenly watching this space with a hope that the true potential of this sector gets unlocked.

This article was originally published in The Economic Times on 27 January 2025 Co-written by: Veena Sivaramakrishnan, Partner; Riddhi Vyas, Research Fellow. Click here for original article

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