When giving banks more power may backfire

There is a story India likes to talk about itself on the global stage, and it goes something like this: we built the Insolvency and Bankruptcy Code (IBC), 2016 from scratch, we handed creditors real teeth for the first time, we cleaned up the banking system, and it worked. Recovery rates that once languished between 15 and 20 per cent under the old patchwork of debt recovery tribunals and SARFAESI proceedings have climbed to roughly 30 per cent under the IBC. S&P Global upgraded India's insolvency regime from Group C to Group B as recently as December 2025. Nine years in, nearly ₹4 lakh crore has been recovered through resolution plans. The numbers are real, and the pride is not unwarranted.

Now Parliament wants to go further and align with global insolvency frameworks. The Insolvency and Bankruptcy Code (Amendment) Bill, 2025 — introduced in the Lok Sabha in August last year, subsequently examined by a Select Committee, and now set to be tabled in the Lok Sabha — proposes what legal analysts have called the most sweeping overhaul since the Code's original enactment. It gives certain financial institutions the ability to initiate insolvency proceedings out of court, tightens admission timelines, and expands the powers of the Committee of Creditors over the liquidation process. The direction is unmistakable: more speed, more certainty, more creditor authority.

And almost nobody is asking whether this is the right direction for India specifically — as opposed to, say, Germany or the United States.

That omission matters. There is a body of research that suggests the impact of strengthening creditor rights on actual borrowing behavior is not universal. It varies — significantly and systematically — with national culture. And when you examine where India sits on the cultural map, the case for omission becomes hard to ignore.

The two-sided ledger that policymakers rarely discuss

The intellectual foundation for creditor rights reform is straightforward. When lenders have stronger legal protection — when they can seize collateral faster, initiate proceedings more easily, and recover more reliably — they are willing to lend more, at lower cost, and on better terms. This is the supply side of the story, and the evidence for it is robust across many countries. India's own experience with the IBC is consistent with it: the cost of debt for distressed firms fell after 2016, and credit channels that had been blocked began to reopen.

But there is a second side to this ledger that rarely makes it into policy discussions. Borrowers have preferences too, and stronger creditor rights change the calculus for them in ways that can run directly counter to what policymakers intend.

When a bank has enhanced powers to seize assets, initiate proceedings, and push a firm into liquidation, the expected cost of bankruptcy rises — not just in practice, but in the minds of the people who run companies. Managers who would otherwise have been willing to borrow and invest start doing something more cautious instead: they reduce their debt, shift toward unsecured financing, hold more cash, and issue more equity. They substitute away from the very instrument the reform was designed to stimulate.

Economists call this the substitution effect, and it is not theoretical. India's own recent history provides the evidence. When the SARFAESI Act was passed in 2002 — giving banks the power to seize secured assets without court intervention — firms did not rush to borrow more on the strength of cheaper credit. Many pulled back. They were not irrational. They were pricing in the new risk that a bad quarter could cost them their factory. The IBC itself has generated similar findings: research documents that firms with high tangible assets — precisely those most exposed to creditor enforcement — reduced their reliance on secured borrowings relative to peers after its implementation, even as the cost of credit fell. 

So creditor rights reforms simultaneously push up credit supply and push down credit demand. Which effect wins in aggregate is not predetermined. It depends on how borrowers and lenders actually respond in practice — and that, it turns out, depends enormously on culture.

The variable that economists keep leaving out

Geert Hofstede's work on national culture, accumulated across decades and now one of the most cited frameworks in cross-cultural psychology, identifies several dimensions along which countries differ in systematic and persistent ways. Two of them are particularly relevant here: individualism and power distance.

Individualistic cultures — the United States scores 91 on Hofstede's scale, the United Kingdom 89, Australia 90 — are characteriSed by high self-reliance, a tendency toward overconfidence in one's own prospects, and a greater appetite for risk-taking. In these cultures, when creditor rights are strengthened, lenders extend credit aggressively because they overestimate their ability to recover, and borrowers take it up because they underestimate the probability that things will go wrong. The income effect dominates. Leverage rises.

High power distance cultures are different. In societies where authority is accepted, hierarchy is deep, and the consequences of failure carry significant social weight, managers are inherently more risk-averse. They do not rush to take advantage of cheaper credit if the price of that credit — in the event of distress — is the humiliation and loss of control that comes with creditor-driven insolvency. The substitution effect dominates. Firms borrow less, not more, when creditors become more powerful.

India scores 77 on Hofstede's power distance index, well above the global average of roughly 56. It scores 48 on individualism — in the collectivist half of the spectrum, a long way from the Anglo-American norm. These are not peripheral data points. They are among the most stable and well-replicated cultural measurements available. And they matter for how Indian managers actually behave when the legal environment shifts.

Multi-country research examining data from over 300,000 firm-years across 31 countries and nearly a quarter century finds exactly this pattern. In high power distance, lower individualism countries, the dominant response to creditor rights strengthening is not to borrow more — it is to borrow less, hold more cash, and issue equity instead. The channel through which the reform was supposed to work gets blocked by the cultural disposition of the very managers it was designed to benefit.

What this means for the Amendment Bill

None of this is an argument against the IBC, or against well-functioning insolvency law. A country where lenders had no reliable means of recovery, where banks sat on mountains of non-performing assets, and where willful defaulters faced no meaningful consequence clearly needed reform. India needed the IBC.

The question being raised here is a narrower and more specific one: as Parliament considers further strengthening creditor rights through the Amendment Bill, are we accounting for how Indian firms and managers are actually likely to respond? Or are we implicitly assuming that Indian boardrooms will behave like their counterparts in Chicago or Frankfurt?

The evidence suggests they will not. The SARFAESI experience is not ancient history — it is a natural experiment that played out within living memory on Indian soil, and its lesson is that Indian firms, when confronted with more powerful creditors, pull back on debt. The IBC has generated analogous findings. And the cultural framework helps explain why: in a society with deep hierarchies and high sensitivity to the social costs of failure, the threat of creditor-driven liquidation is not a background technicality. It is a vivid and frightening prospect that changes behavior before any default has even occurred.

This means the Amendment Bill's primary intended benefit — more credit flowing into the economy — may be partially offset by demand-side retrenchment that nobody in the policy process is measuring. Firms that might have borrowed to invest may instead sit on cash. Companies that would have used secured bank loans may migrate to other instruments. The aggregate effect on credit growth could be considerably more muted than projections suggest.

There is also a secondary concern that deserves attention. The Bill's provisions for creditor-initiated insolvency outside the court process give certain financial institutions a faster and more direct path to enforcement. For banks managing portfolios of large, secured, long-term loans, this is unambiguous good news. But for the promoters and managers of the firms on the other side of those loans, it raises the stakes in ways that are not trivial in a high power distance culture. The knowledge that a lender can move more swiftly and decisively may not make them more willing to borrow — it may make them less willing.

A question for the World Bank, too

This argument carries implications beyond India's domestic policy debate. For years, the World Bank's Ease of Doing Business rankings have used the strength of creditor rights as a positive indicator — something governments are implicitly encouraged to maximize. Numerous emerging market countries have undertaken creditor rights reforms in response to this signalling, often without asking whether the expected benefits will actually materialize in their specific cultural and institutional contexts.

The research discussed here raises a direct challenge to that framework. If the impact of creditor rights strengthening depends fundamentally on the cultural disposition of borrowers and lenders — and the evidence suggests it does — then a one-size-fits-all prescription is not just incomplete. It may be actively misleading for countries that score high on power distance and low on individualism, which includes a significant share of the emerging world.

India, currently positioned to pass its most ambitious creditor rights legislation since 2016, is an important test case. The right policy outcome is not weaker creditor rights — it is creditor rights that are calibrated in their design and phasing to account for how Indian firms actually respond to enforcement risk. That might mean complementing stronger enforcement mechanisms with specific safeguards that reduce the liquidation threat perceived by going-concern firms. It might mean paying closer attention to the demand side of the credit market, not just the supply side. It might mean asking, before the Bill passes, what the evidence from India's own recent history tells us.

Because if the primary effect of further strengthening creditor rights in India is to make Indian managers more risk-averse about borrowing, we will have built a more powerful machine for recovering debt from the few firms that fail — while inadvertently discouraging the broader investment activity that generates growth and prevents failure in the first place.

That would not be a small irony. It would be a significant and avoidable policy mistake.

(Views are personal; Rama Seth is Associate Professor, Copenhagen Business School, Department of Finance, Harshal Rajan Mulay is Assistant Professor, Indian Institute of Technology Kanpur, Department of Management Sciences, and Arpita Ghosh is Professor, Indian Institute of Management Calcutta, Finance and Control Department)