Insufficiency of the Insolvency and Bankruptcy Code in the resolution of banks

The Insolvency and Bankruptcy Code, 2016 (“Code”), has created a lot of confusion in the past regarding their resolution over the banking sector and the other financial service providers. The inefficiency of the said code to regulate these institutions lies in the nature of its applicability. The code is clearly enacted in a manner that it resolves the bankruptcy issues pertaining to other financial sectors and going concerns, and not the banks specifically. The functioning of the financial service providers differs at its core from other financial institutions, making it difficult for the code to regulate it. 

Firstly, the code outrightly excludes banks and other such financial service providers from within its definition of who the corporate persons are under Section 3 (7) of the said code[1]. Although, they can be a part of the Committee of Creditorswhich is established against the corporate debtor, however, they would not be a part of the resolution process. 

Secondly, insolvency is a credit driven matter, which is highly unfeasible for the banking sector owing to the dependency individual banks have on each other for access to credit facilities. In other sectors, if a corporate becomes insolvent, the same does not generally have an effect on the other organisations in the same sector. However, owing to the aforementioned dependency, a domino effect happens in the banking sector, leading to a collapse of the entire system, primarily if a big investment bank or corporation is involved. Therefore, having an independent organisation deal with such matters pertaining to the bank would be a necessary step for its resolution.[2]

Thirdly, financial institutions and banks are more prone to vulnerability under this code owing to the dependency they have on public confidence. Depositors tend to pull out their deposits in situations of bad rumour about the bank. Such loss of public confidence does not just effect one bank but a series of them owing to the dependency they have on one another. This domino effect causes a chain of events where numerous banks are in trouble owing to the loss of public confidence of one bank. Therefore, even during a financial stress, there is not an immediate loss of values by the assets in other sectors. But, the same is untrue for the banking sector because there, the value of the assets start falling immediately, in turn making liquidation impossible. Such drop in the value of assets needs to be regulated by a separate regime from that of the code as the same does not seem to efficiently regulate the banking sector.[3]

As stated above, an outright exclusion has been done under the code of the banks and other financial service providers, however the same can be brought within its purview through special notifications. Since bankruptcy under the code is a credit-driven process, the resolution would not be effectively applicable to bankss owing to the nature of their functioning. In banks, depositors are generally the creditors, therefore the liquidation process cannot be dependent on them as their interests have to be prioritized first. Moreover, except the depositors, there is a wide range of the kind of creditors a bank has. Owing to this, their coordination becomes a struggle and dependency on them to initiate the insolvency process becomes doubtful. Therefore, having a separate act and an independent body regulate this sector would be an important step towards achieving clarity and better coordination in the process.

In 2017, the  Financial Resolution and Deposit Insurance Bill, 2017 (“FRDI Bill”) was introduced in the parliament to cater to such needs and fill the aforementioned loopholes in the system. However, the same was withdrawn owing to the criticisms of the depositors and other stakeholders regarding the bail in[4] provision. It is believed that this would have been the best solution to address the issues mentioned in the abovementioned paragraphs and would have somewhat dealt with the resolution problem of the banking sector.[5]


[1] Insolvency and Bankruptcy Code, 2016, S. 3 (7).

[2] Chaliya, Gaurav. “Gaurav Chaliya.” National Law School of India Review, 23 July 2020, https://nlsir.com/need-for-a-separate-insolvency-regime-for-banks-in-view-of-the-yes-bank-debacle-in-india/.

[3] Chaliya, Gaurav. “Gaurav Chaliya.” National Law School of India Review, 23 July 2020, https://nlsir.com/need-for-a-separate-insolvency-regime-for-banks-in-view-of-the-yes-bank-debacle-in-india/.

[4] A bail-in provision provides that the creditors would bear a part of the cost of a bank’s failure by the reduction in their claims to some extent.

[5] Chaliya, Gaurav. “Gaurav Chaliya.” National Law School of India Review, 23 July 2020, https://nlsir.com/need-for-a-separate-insolvency-regime-for-banks-in-view-of-the-yes-bank-debacle-in-india/.

Aishwarya Says:

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