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Bankruptcy regime change and credit risk premium on corporate bonds: Evidence from the Indian economy

Rajeswari Sengupta and Harsh Vardhan ()

Indira Gandhi Institute of Development Research, Mumbai Working Papers from Indira Gandhi Institute of Development Research, Mumbai, India

Abstract: Enactment of the Insolvency and Bankruptcy Code (IBC) in 2016 marked a watershed event in the commercial credit landscape in India,and represented a major enhancement in the rights of creditors. In this paper we hypothesise that in the new regime, creditors would demand a lower price for credit now that the IBC has strengthened their rights in the event of a borrower defaulting. We focus on one class of creditors--investors in the bond market. We consider IBC as a quasi-natural experiment and empirically investigate its impact on credit spreads in the corporate bond market in India. We find that post IBC, credit spreads declined for the non-financial firms in the private corporate sector. However, even for these firms, bond investors seem to assign greater importance to firm-specific characteristics such as firm size and firm financial health compared to the impact of the new bankruptcy regime. It is plausible that a few years after IBC was implemented, the general discontentment in the financial markets regarding the effectiveness of the bankruptcy law may have dampened the effect on credit spreads. Ours is the first study to analyse the influence of the IBC on the cost of credit in the bond market. Currently, the bond market in India is skewed towards high rated bonds which account for the bulk of all issuances. In order to develop a deep and liquid market for lower rated bonds, investor confidence in effective bankruptcy resolution will be crucial. This study provides us with valuable insights about the reaction of the bond investors to the IBC.

Keywords: Bond pricing; Credit spreads; Bankruptcy law; Creditor rights; Credit rating; Maturity; Liquidity; Risk perception (search for similar items in EconPapers)
JEL-codes: G12 G32 G34 (search for similar items in EconPapers)
Pages: 28 pages
Date: 2023-02
New Economics Papers: this item is included in nep-cfn, nep-fmk and nep-rmg
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