Deep haircuts: Comparing realizations to outstanding loans is not useful in assessing the effectiveness of IBC, says RBI DG


“Must compare realization with liquidation, the only other alternative for creditors”

“Must compare realization with liquidation, the only other alternative for creditors”

Comparing outstanding loan amounts to realized value may not be a “reasonable indicator” to gauge the effectiveness of the bankruptcy law, Reserve Bank Deputy Governor M Rajeshwar Rao said while trying to allay concerns about the deep haircuts being taken by banks in part of the bankruptcy resolutions had been made plans.

Admitting there have been concerns, Mr Rao said one must understand that by the time it comes to court, the asset’s value may already have deteriorated, adding that one should compare the realizations with the liquidation, which is what the best possible alternative for lenders.

“We miss the fact that in a public auction-based resolution model, the haircut level representing a market-required haircut to continue investing in an insolvent borrower with the outstanding amount may not be an adequate indicator to assess the effectiveness of the resolution.

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

Financial creditors were able to realize 166% compared to debtors’ liquidation value, suggesting creditors were better off than the next logical conclusion, he added.

It should be noted that some decisions, such as in the Videocon case where the new owner received the asset for just ₹2,900 crore versus recognized claims of 46,000 crore from creditors, had raised concerns about the effectiveness of the process. Industrialist Harsh Goenka had claimed that such decisions were “stealing” public funds.

Mr. Rao mentioned the Videocon resolution but in the context of improving group resolutions within the IBC framework.

The Deputy Governor said the Videocon resolution occurred through discretionary powers available to the deciding authority and not through a feature of the Insolvency and Bankruptcy Act.

“Such a process (in the Code) is particularly important in an economy like India, where traditionally loan agreements have been embedded with mutual obligations and credit-mitigating collateral from a borrower’s parent and affiliated companies,” he noted.

Mr Rao also said there was a need to extend the “pre-pack resolutions” to all borrowers, beyond the currently permitted small businesses, to make them more effective.

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

Filing for bankruptcy as a negotiation tactic appears to work for operational creditors, Mr Rao said, noting that as of December 31, 2021, corporate bankruptcy filing data indicated that more than 51% of cases had been filed by operational creditors, but that they accounted for 71% of all payouts.

The IBC is also acting as a credible threat, he said, adding that 19,800 applications to initiate the CIRP with an underlying default of around ₹6.1 lakh crore were settled before court admission.

Gracing the researchers’ attention, Mr Rao said efforts need to be made to examine the average time that elapses between a borrower’s default and creditors’ eventual filing for bankruptcy resolution.

“The connection between such filing delays and the impairment that creditors have to acknowledge retrospectively should also be interesting,” he added.

The IBC has had a “profound impact” on the creditor-debtor relationship in India over the past five years and the RBI would continue to work with stakeholders to improve resolution frameworks and introduce more sophisticated and updated risk management practices to address systemic ones He assured that there were concerns arising from the activities of the various credit intermediaries.

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