Is IBC the best resolution option for NBFCs?

Since 2019, three prominent non-bank financial companies (NBFCs) have gone down the road to bankruptcy. It started with Dewan Housing Finance Corporation when the Reserve Bank of India through an amendment to the Act included Financial Service Providers (FSPs) in IBC’s method of resolving stress. Financial service providers were not part of the initial list.

But today with the attempts at dissolution in the Reliance Capital and Srei group of companies stretching like mud, unsure of the final outcome, it is pertinent to ask whether the inclusion of FSPs in the IBC has produced the desired results.

There are doubts about its effectiveness as the solution process is complicated by the diverse nature of the business, underlying assets and customer-facing business models.

One major difference is the lack of tangible assets such as land, plant and machinery and fixed assets in the case of manufacturing industries and allied sectors. Add to the fact that the deterioration in financial assets due to business recession is faster compared to those businesses built on fixed assets because unlike the latter, it is the leverage and cash of financial service providers that keeps them going.

Once that is cut, which is bound to happen when IBC procedures are initiated, it makes the value realization mechanism difficult.

As such, most decisions under an IBC take more than a 270-day schedule and the average realizable value is less than 35 percent.

“For financial assets, it is difficult to be certain of a certain value because unless they are resolved faster, they deteriorate much faster than other entities,” said Soumyajit Newgi, India Ratings Director.

Businesses and subsidiaries also suffer from the delay of these companies in making strategic decisions that must be taken in the board of directors of the holding company and / or positions of shareholders.

Uday Kotak, managing director and CEO of Kotak Mahindra Bank who has headed embattled IL&FS for more than three years has a similar view. “The NCLT process is lagging behind whether IBC or otherwise. In IL&FS too, while the recovery ratio is better, the legal process takes too long. It is time to revisit the policy in the financial sector decision.”

On average, loans to non-bank financial institutions account for 11-13 percent of the total loans extended by banks. The domino effect that failures of financial service providers can have on banks cannot be ignored, and unlike brick-and-mortar companies that go bust, the impact of contagion on peers and larger subclasses due to failing FSBs could be higher. It also increases risk aversion towards the sector where public money is involved.

On the bidders end, the financial service providers solution requires the additional task of refunds, collections, and customer obligations. Depending on the nature of the business and product mix, bidders may have to consider various options such as securitization, one-off settlements and selling to asset rebuilding companies (ARCs) for resolution and integration, all of which point to a long and grueling battle that bidders may want to avoid. However, what if the asset is no longer profitable or entails a drastic cut for the lenders.

“The solution becomes a lengthy process because potential bidders also have to redeem these loans and only after that they can pay the stakeholders and it can take a few years to recover the loan,” said Sudhir Chandy, Director, Resurgent India.

There is also an additional element of regulatory oversight in FSPs’ solution, which could add to delays.

To be fair, the regulator-driven model helps financial service providers bypass frivolous applications while allowing for informed regulatory decisions regarding the public money and securitized assets held by the entity.

However, additional compliance, regulatory approvals, NOC requirements and the designation of a regulator-backed official may add to delays and potential conflicts over the value of the decision and the process, unlike in most other cases where the creditors committee (Code of Conduct) has say the only. It is also possible that the administrator appointed by the regulator may not have the experience or bandwidth to manage large companies, especially when there are several subsidiaries involved.

RCap is a comprehensive example that shows everything that can go wrong in an IBC-led process.

Thus, as actions are prioritized, urgency in the decision takes a backseat leading to diminishing filter value.

For example, under the guise of value maximization, how often the Code of Conduct can (and has) call for bids or suspend challenge mechanisms. As the process unfolds, this turns into a major contention in the case of RCap’s resolution.

Would it then be better for ARCs to deal with and convert stressed financial service providers?

“The ARC model has been time-tested and it works because it helps liquidate those assets faster. Given the choice, is the relatively more efficient or better model,” Newgi said, adding that since financial assets tend to be fragmented, the preference is to consolidate them before choosing solution or liquidation.

It could certainly be a better option versus liquidation which may take longer for the administrator to navigate SARFESI or other recovery modes and then distribute the proceeds to creditors.

But one of the main advantages of the IBC-led recovery is that in the challenge mechanism bidders commit a large portion of bids as cash advance, thus resolving the short-term liquidity crunch. Another advantage is that on purpose, an IBC is not only focused on insolvency and recovery but also aims to ensure that the company remains an ongoing concern when a new home is found.

Maybe then, the process is still very early days and one will have to give it time and bandwidth to grow.

Mukund b said. Unni, High Court Registered Attorney: “Whenever there is a new amendment, it is through these suits and processes that it is finally settled and the law becomes clear.”

“In that sense, it’s good that there are some court cases going on, as the Supreme Committee will finally explain how this should be done,” he said, adding that with the Supreme Court’s ruling on RCap expected in 3-4 months, things will become clearer on aspects of the decision mechanism. .

Meanwhile, some support such as amendments to speed up the insolvency process and clarification of regulations to avoid fragmented, biased and unsatisfactory outcomes may help financial service providers.

“There may be some enabling provisions in the RBI Code to streamline the process in terms of onboarding new promoters and speed up the process because speed is key,” said Chandy.