IBC News: Deep haircuts: Comparing realisations with outstanding loans not reasonable to assess IBC effectiveness, says RBI DG

Seeking to address concerns over the deep haircuts taken by banks in some of the insolvency resolutions, Reserve Bank Deputy Governor M Rajeshwar Rao on Saturday said comparing the outstanding loan amounts with the value realised may not be a ‘reasonable indicator’ to assess the bankruptcy law’s effectiveness.

Admitting that there have been concerns, Rao said one needs to understand that the value of the asset may have already deteriorated by the time it comes up at the courts, and added that one should compare the realisations with liquidation, which is the best possible alternative for lenders.

“We miss the fact that in a public auction-based resolution model, the extent of haircut represents a discount the market demands in continuing to invest in an insolvent borrower. Since significant value deterioration may have happened to the assets of the insolvent borrower, comparison with the outstanding amount may not be a reasonable indicator to evaluate the effectiveness of the resolution.

“Rather, the resolution values must be compared with the next best alternative for the creditors, which in this case is liquidation,” Rao said, addressing an event at the IIM-A.

Financial creditors have been able to realise 166 per cent in comparison to the liquidation value of the debtors, indicating that creditors have been better off than the next logical outcome, he added.

It can be noted that some resolutions like Videocon, where the new owner got the asset for only Rs 2,900 crore as against admitted claims of Rs 46,000 crore from creditors had led to concerns about the effectiveness of the process. Industrialist Harsh Goenka had alleged that public money was being “stolen” through such resolutions.

Rao did mention the Videocon resolution but in the context of improving the group resolutions within the IBC framework.

The DG said the Videocon resolution took place through discretionary powers available to the adjudicating authority rather than through a feature of the Insolvency and Bankruptcy Code.

“Such a process (in the code) is especially vital in an economy like India, where traditionally credit contracts have been embedded with cross obligations and credit mitigating covers provided by parent and group companies of a borrower,” he noted.

Rao also said that there is a need to extend the ‘pre-pack resolutions’ to all the borrowers, beyond the presently permissible small businesses to make it more effective.

He also added that the bankruptcy law should be used as a last resort by all the lenders in the system.

Filing of insolvency proceedings as a negotiating tactic appears to be working for the operational creditors, Rao said, pointing out that as of December 31, 2021, the corporate insolvency resolution process data suggested that more than 51 per cent of the cases have been filed by the operational creditors but they accounted for 71 per cent of the total withdrawal cases.

The IBC is also acting as a credible threat, he said, pointing out that 19,800 applications for initiation of CIRP having an underlying default of about Rs 6.1 lakh crore were resolved before admission in the courts.

Drawing researchers’ attention, Rao said efforts must be devoted to study the average time taken between default by a borrower and the eventual filing of an application for the insolvency resolution by creditors.

“It should also be interesting to see the relationship between such filing delays and the value deterioration that the creditors are required to recognise subsequently,” he added.

The IBC has had a “profound impact” on the creditor-debtor relationship in India in the last five years and the RBI will continue to engage with the stakeholders to improve the resolution frameworks, and adopt more sophisticated and updated risk management practices to take care of systemic concerns that arise from the activities of the various credit intermediaries, he assured.