In May of 2016, India adopted a regime for personal insolvencies and bankruptcies as part of a comprehensive Insolvency and Bankruptcy Code. The Code's provisions for commercial debtors have been in force for over a year, but provisions for individual debtors have not yet gone into force. The Insolvency and Bankruptcy Board of India has indicated that those provisions will be given effect in the relatively near future. Meanwhile, there has been very little public discussion or commentary within the country or elsewhere about them. Those provisions will introduce a new and complex system of legal tools for citizens across India's financial spectrum and their lenders. It is surprising and unsettling that fundamental questions about the purpose and likely impact of these provisions remain largely unaddressed in public discourse.
My working paper, Anticipating the Function and Impact of India's New Personal Insolvency and Bankruptcy Regime, describes the new personal insolvency and bankruptcy regime in some detail; analyzes the goals of policymakers who drafted and enacted the regime; assesses the design of the regime in light of those goals; and anticipates the function and impact of the law as enacted.
There is relatively little in the public record about the precise goals that policymakers had in mind in designing and adopting the personal insolvency and bankruptcy provisions of the Code. It appears that, to the extent that policymakers considered non-business debtors in drafting and enacting the Code, their primary goal was to promote increased consumer lending in the economy and, secondarily, to provide some degree of protection to individuals in financial distress, especially from aggressive debt collection. Unlike the provisions for corporate debtors under the new Code, the provisions for personal insolvency and bankruptcy do not appear to have been driven by acute economic or financial conditions. Thus, the Code appears to represent a rare instance of a country adopting or modernizing a personal insolvency or bankruptcy regime at the relatively early stages of the development of a consumer financial market, before one is acutely necessary. Doing so may have a beneficial effect on the development of that market. If well-designed and operated, a personal insolvency or bankruptcy regime can help promote a stable market for consumer credit, making creditors more willing to lend and individuals more willing to borrow, disciplining both, reducing the social costs of consumer financial distress and perhaps the amount of household over-indebtedness in the economy as well.
But such potentially beneficial effects likely depend on a system that improves or accelerates creditors' insolvency state returns, or at least makes their losses relatively predictable, and that effectively insures individuals against the risk of over-indebtedness without creating incentives for them to act opportunistically or recklessly. It is not clear how well the provisions for personal insolvency and bankruptcy under the Code as enacted will serve these functions, and there are some causes for concern.
The Code includes a fresh start process for individuals with low incomes, few assets, and relatively little debt, which provides a very robust insurance function. It is likely, however, that most debtors will only be eligible for the Code's insolvency process, which requires a repayment plan approved by creditors and which provides more limited relief and protection. The bankruptcy chapter of the new Code may provide more meaningful debt relief to individual debtors, but they will only be eligible for bankruptcy if they first try the insolvency process. Furthermore, it is likely that large segments of the population of individual debtors covered by the law will not have sufficient information about the law to utilize it, will face logistical challenges even if they do have sufficient information, or will be deterred by stigma or other reputational concerns.
It is possible, therefore, that a significant portion of debtors in financial distress will not voluntarily use the new insolvency and bankruptcy regime and that it will primarily be employed as a debt collection tool for creditors. If so, the scope of the insurance function of the new system may not end up providing sufficient relief to individual debtors who become mired in debt, may not promote risk-taking entrepreneurial activity, and may not provide a meaningful safety valve to developing consumer financial markets.
A longer version of this post was published first here.