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Tuesday, October 24, 2006

Need for personal bankruptcy law

Lack of a personal bankruptcy laws is one of the many ironies of the state of legal system in India.

Picture this, if a company gets into a situation of too much debt (either because it takes on too much debt in absolute terms or because its repayment ability falls), it has many avenues to restructure its debt, to pay lower interest rate, to have debt waived off temporarily or permanently, fully or partly. The business gets protection from seizure of property/assets so that it can continue normal operations. Indeed the SARFAESI Act was passed a couple of years ago, because the bankruptcy law was too heavily skewed in favor of (commercial/corporate) borrowers.

However, if an individual gets into too much debt, he is doomed. He has almost none of the options mentioned above as being available to commercial/corporate borrowers available to him. Farmers are comitting suicides every day because of being in a debt trap.

Logic demands that if a company has the option of getting its debt restructured, interest and/or principal waived/reduced then so should an individual. But this does not happen in a formal sense. It needs the problem getting out of control (which means lots of suicides and lots of headlines) before the political class 'comes to the rescue' and a temporary 'band-aid' is put on. But this essentially is a one size fits all approach and the decision is 'forced' onto the lending institutions which is unfair. So, we a formal legal procedure that is put up once and for all, else this process is repeated almost every other year.

In fact I would argue that the need for having a bankruptcy law is even greater for individuals than for corporates. In case of invidiual it is often the question of survival. Secondly, a company getting into a debt trap can be put an end (be liquidated) - but you cannot do that with an individual. So, in case of an invidual/household getting him/them out of debt is the ONLY option. Secondly, once in a debt trap unless there is some structural mechanism available, it is almost impossible to come out of it thanks in no small way to 'compunding' the 8th wonder of the world as Einstein put it. Thirdly, in case of individuals, debt trap affects not just that person but his family - so there is collateral damage (Ironically, in case of corporate its employees may get laid off nor not get paid and it is then that they need help with their debts and it is precisely then that they do not get any help while their company continues to get benefits!)

Now, it is not my argument that banks/lenders in India are insensitive or unaware of this. Nor is it my claim that banks/borrowers are overly harsh all the time. But it is certainly my case that there is no formal law which lays down ground rules of how to deal with such a situation, the rights of borrowers (it cannot be the case that banks/lenders have all the bargaining power) and the various types of settlements which are possible so that borrowers can have a reasonable hope of getting out of the miserable situation they find themselves. We need a proper law which puts this and many other things in writing.

For example, the personal bankruptcy law (which incidently was tightened a year or so bank as it was perceived to be too lenient and favouring the borrowers!) covers things like who is eligible to claim personal bankruptcy, under what circumstances, what are the assets that cannot be seized, how and to what extent can debt be waived off or deferred etc etc etc. All these are fairly important issues.

Now, the immediate reason for writing this post is the farmer's suicides. But the need for this law will increasingly be felt as the 'credit' culture gets seeped in the soul of this country. Hitherto, since credit penetration at a personal level was very low, the need for this law was not felt (apart from to the extent individual businesses/farmers etc borrowed). However as increasingly almost every thing is brought on credit (remember credit card is nothing but a unsecured loan!) and as the marketing departments of all financial institutions work overtime in trying to get people take on credit - it will not be surprising to see more and more people getting into debt traps.

In fact another side benefit of this law would be that if banks have to take some losses under this law - either through deferrals or waivers etc, it will force their marketing managers to use a bit of judgement in extending credit.

That's it for now...

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