Resolution of Stressed Assets
The Insolvency and Bankruptcy Code (IBC) in 2016 was a paradigm shift in the ethos for resolution of stressed assets in India. In recent years, however, declining rates of recovery in comparison to their claims admitted through this mechanism has raised concerns1. The rate of recovery is contingent on several factors, including the overall macroeconomic 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.
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. 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. Data indicate that at endSeptember 2022, in cases where the corporate insolvency resolution processes (CIRPs) were initiated by financial creditors (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. 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. Through another amendment to IBC regulations, performancelinked 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.
The pre-packaged insolvency resolution process combines the best of the out-of-court resolution efforts and the 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 the Reserve Bank, if extended to all borrowers. 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.
(Source: RBI Report on Trend and Progress of Banking in India, released on 27.12.2022, page 2 to 3, para I.6 to I.9 of the Report)
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