IBC: Resolution value may be compared with liquidation value of stressed assets, says RBI – The Hindu BusinessLine

Clipped from: https://www.thehindubusinessline.com/money-and-banking/ibc-resolution-value-may-be-compared-with-liquidation-value-of-stressed-assets-says-rbi/article66311267.ece

Comparison of realised value with admitted claims may not be reasonable indicator of effectiveness of the resolution process, says RBI report

Declining rates of recovery in recent years in comparison to their claims admitted through the Insolvency and Bankruptcy Code (IBC) mechanism has raised concerns, according to a Reserve Bank of India report.

As on September 30, 2022 the realisation was 33 per cent of total claims in cases where corporate insolvency resolution processes (CIRPs) were initiated by Financial Creditors (FCs), per the report on Trend and Progress of Banking in India 2021-22.

Dependent on factors

RBI noted that the rate of recovery from stressed assets is contingent on several factors, including the overall macro-economic environment, perceived growth prospects of the entity and its sector, and the extent of erosion in the intrinsic value of the entity.

As a broad-based recovery gains traction, these factors are likely to turn favourable for financial resolution, it added.

The central bank emphasised that in a public auction-based resolution model such as the IBC, the extent of haircut represents the discount the market demands for acquiring the stressed entity as a going concern.

It observed that since significant value destruction may have already happened in these assets, a comparison of realised value with admitted claims may not be a reasonable indicator of the effectiveness of the resolution process. Rather, the resolution value may be compared with the liquidation value of stressed assets.

201% of liquidation value

Data indicates that at September-end 2022, in cases where the CIRPs were initiated by FCs, the realisation through the IBC was close to 201 per cent of the liquidation value. Within the IBC framework, the time taken for admission of resolution application as well as the final resolution and liquidation has steadily increased, according to the report.

The central bank noted that the Insolvency and Bankruptcy Board of India (IBBI) recently amended the CIRP regulations aimed at improving realised value, reducing delays in the process, enhancing efficiency of available time and improving information availability.

Incentives

Through another amendment to IBC regulations, performance linked incentives have been introduced for insolvency professionals, which should help in maximising the realised value of stressed assets beyond their liquidation value, and in their timely resolution.

Best resolution

RBI observed that the pre-packaged insolvency resolution process combines the best of the out-of-court resolution efforts and judicial finality of a resolution plan. This mechanism, which is allowed only for micro, small and medium enterprise (MSME) borrowers, may effectively complement the prudential framework of RBI, if extended to all borrowers, it added.

Cross obligations

The central bank said in India, credit contracts are often embedded with cross obligations and credit risk mitigation covers provided by parent and group companies of the borrower. “In such a system, a default by one borrower is likely to spur cross defaults by group companies, thereby increasing the overall credit risk to the financial system.

“A group resolution framework, in which the resolution of borrowers belonging to the same corporate group if undertaken together, could help in improving the efficacy of the IBC,” the central bank said.

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