Create a Bankruptcy Resolution Process for Financial Firms in India

By Kriti Upadhyaya —

Source: Visual Content’s flickr photostream, used under a creative commons license.

Status: In Progress On November 15, 2019 the Ministry of Corporate Affairs (MCA) enacted the Insolvency and Bankruptcy Code (IBC) Rules 2019 to enable the application of the IBC to Financial Service Providers (FSPs), subject to central government notification. A second notification on November 18, 2019 allowed non-banking financial corporations (NBFCs) with assets worth $69 million or more to file for resolution under the IBC. This is to be read with Section 45 MBA of The Reserve Bank of India (RBI) Act, as inserted through the Finance Bill 2019 – specifying tools given to the RBI to deal with insolvency of non-banks. The IBC Ordinance 2019 also clarified certain issues on application of the IBC to FSPs. All these measures have fallen short of creating a dedicated body for FSP bankruptcy resolution. A draft “Financial Resolution and Deposit Insurance Bill” was introduced to Parliament in 2017 but has been withdrawn.

Legislation: No Opposition, Political Will The creation of a distinct framework for the resolution of FSPs including banks will most likely require legislation. It is on the government’s agenda as it accepts that the IBC provisions as applied to FSPs are interim ad-hoc measures.

This is the twenty-second installment in a new series of articles on the India Reforms Scorecard: 2019-2024 by the staff and experts at the Wadhwani Chair in U.S.-India Policy Studies. The series seeks to provide analysis on why reforms marked as “Incomplete” or “In Progress” have not been completed, and the impact such reforms can have on specific sectors or the economy at large.

The IBC was enacted in 2016 to battle India’s rising level of non-performing assets. The National Companies Law Tribunal (NCLT) was set up as a dedicated bench to handle these cases. Although the expansion of IBC is a welcome interim measure, it raises questions about the adequacy of the IBC and NCLT in handling FSP resolutions. Further, including some FSPs within the IBC can overload the already heavily burdened process. Indian financial firms need a separate resolution authority altogether with a sharper focus and technical expertise; and the ability to handle all types of FSPs, including banks. Until the recent RBI notifications, NBFCs did not have a specific provision for resolution of stressed assets. New management could not take over and revive the NBFCs.  The new notifications allow NBFCs that earlier had no recourse to trigger a resolution process. Like Diwan Housing Finance Corporation- the first to trigger the insolvency resolution process corporate (CIRP) under the new provisions.

However, the lack of a separate mechanism glosses over some structural issues. This is because unlike corporate firms, FSPs have a greater obligation towards continuation of their financial services, and a larger and more diverse creditors’ base that makes coordinated creditor mobilization difficult. Pursuant to this, The Financial Stability Board has laid down guidelines for FSPs in Key Attributes of Effective Resolution Regimes for Financial Institutions.

More importantly, the notifications until now only address NBFCs (including housing finance companies), leaving out other categories of FSPs. Further, a great deal of regulatory authority remains with the RBI, thwarting any headway that the administrator may gain in turning around assets – similar to the problems being experienced by insolvency resolution professionals of sick companies in NCLT. This also means that no one, not even depositors, can initiate the process except RBI. Lack of administrative staff, technical staff, and judicial staff  are issues for the NCLT and may worsen as case-loads increase.

With the NCLT already clogged up, adding NBFC cases will further reduce the effectiveness of the whole resolution process. Currently, the NCLT hears all cases related to corporate disputes and winding-up of companies – not just IBC cases. Added to this, NCLT also hears real estate cases which could have been referred to the Real Estate Regulatory Authority (RERA). All these factors increase the burden on the NCLT, affecting its efficiency.

The best outcome of an insolvency/bankruptcy process is resolution or restructuring as opposed to outright liquidation. This ensures the entity does not lose value and more competitive promoters can potentially take over; continuing the entity’s life. Resolution plans yield 208 percent more value than liquidation just based on past CIRP data.  Although the fear of liquidation helps keep unscrupulous promoters on their toes, liquidation remains the worst possible outcome. Charts below summarize the outcomes of the CIRP since the IBC’s inception until last quarter ended in December 31, 2019.

Source: Insolvency and Bankruptcy Board of India’s Quarterly Newsletter (Oct-Dec 2019), chart compiled by the author.

Source: Insolvency and Bankruptcy Board of India’s Quarterly Newsletter (Oct-Dec 2019), chart compiled by the author.

A majority of cases are being disposed through liquidations and there are also inordinate delays within the NCLT. This is a critical factor as insolvency in the case of FSPs can be much more lethal than insolvency of a firm – requiring all the more reasons to ensure resolutions through other means like restructuring.

The new notification on FSPs which applies the IBC mutatis mutandis to NBFCs is a welcome step. However, given the structural issues and current burden on the NCLT, this hasty measure is insufficient. The need of the hour is a full-fledged Financial Resolution Authority which the Modi government first considered in its first term.

Ms. Kriti Upadhyaya is a research associate with the Wadhwani Chair in U.S.-India Policy Studies at CSIS.

Share

Leave a Reply

Your email address will not be published. Required fields are marked *