Since 2019, three notable non-bank financial corporations (NBFCs) have opted for insolvency. 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 way of resolving stress. Financial service providers were not part of the initial list.

But today, with resolution attempts at Reliance Capital and the Srei group of companies spreading like slime, unsure of the end result, it is pertinent to ask whether the inclusion of financial service providers in IBC has produced the desired results.

There are questions about its effectiveness as the resolution process is complicated due to the varied nature of the business, the underlying assets and their customer-facing business models.

One of the main differences is the absence of tangible assets such as land, factories, machinery and fixed assets in the case of manufacturing and related sectors. Add the fact that the deterioration of financial assets due to business stagnation is faster compared to businesses built on fixed assets because, unlike the latter, for financial service providers leverage and cash is what it keeps them going.

Once it’s cut, which is bound to happen when IBC proceedings start, the realization of value mechanism is going to be a challenge.

As such, most IBC resolutions take longer than the 270-day time frame and the average realizable value is less than 35 percent.

“For financial assets, it’s hard to pinpoint a particular value because unless it resolves faster, it deteriorates much faster than other entities,” said Soumyajit Niyogi, director of India Ratings.

Businesses and subsidiaries also suffer because these companies fall behind on strategic decisions that need to be made at the board of directors and/or holding company shareholder positions.

Uday Kotak, MD and CEO, Kotak Mahindra Bank, who chaired the embattled IL&FS for more than three years, is of a similar opinion. “The NCLT process is behind schedule, be it IBC or otherwise. In IL&FS too, although the recovery rate is better, the legal process takes a long time. It is time to review the resolution policy of the financial sector, ”he said.

On average, loans to NBFCs represent 11 to 13 percent of total loans made by banks. The ripple effect that FSP failures could have on banks cannot be ignored and, unlike physical companies failing, the contagion impact on peers and larger subsections due to FSB failures can be older. It also increases risk aversion towards the sector since it deals with public money.

On the part of the bidders, the resolution of PSF requires the additional task of recoveries, collections and commitments with clients. Depending on the nature of the business and product mix, bidders may need to consider various options, including securitization, one-time deals, and sale to ARCs for resolution and integration, all of which point to to a long and tedious battle. that bidders may want to avoid. Despite this, what if the asset is no longer as lucrative or involves a stiff haircut for lenders?

“The resolution becomes a lengthy process because the prospective bidders also have to recover these loans, and only then can they pay the interested parties and the recovery of the loan may take a few years,” said Sudhir Chandi, director of Resurgent India.

There is also the added element of regulatory oversight in the resolution of financial service providers, which could increase delays.

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

However, additional compliances, regulatory clearances, the requirement for a ‘certificate of no objection’ and the appointment of a regulator-backed administrator can increase delays and potential disputes over value and the resolution process, unlike most other cases where the committee of creditors (CoC) has the sole say. It is also possible that the administrator appointed by the regulator may not have the experience or the bandwidth to manage large companies, especially when there are multiple subsidiaries involved.

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

Consequently, with the priority of the procedures, the urgency in the resolution passes to the background, which leads to a decrease in the liquidation value.

For example, under the pretext of value maximization, how many times can the CoC (and has already done so) invite bids or conduct challenge mechanisms? As the process evolves, this is becoming a major controversy in the RCap settlement case.

So would ARCs be better managed to treat and recover stressed financial service providers?

“The ARC model is time-tested and has been working in helping to liquidate those assets faster. Given the choice, it is the most efficient or relatively best model,” Niyogi said, adding that because financial assets tend to fragment, the preference is to consolidate them before opting for resolution or liquidation.

It can definitely be a better option versus liquidation, which could take more time for the servicer to navigate through SARFESI or other recovery modes and then distribute the funds to creditors.

But one of the main advantages of the IBC-led recovery is that, in the challenge mechanism, bidders commit a substantial part of the bids as initial cash, thus resolving the short-term liquidity bottleneck. Another advantage is that IBC intentionally not only focuses on insolvency and recovery, but also aims to ensure that the company remains a going concern when finding a new haven.

Perhaps then, the process is still in its infancy and will have to be given time and bandwidth to grow.

“Every time there is a new amendment, it is through these litigation and processes that it is finally established and the law is clarified,” said Mukund P Unny, a registered attorney with the Supreme Court.

“In that sense, it is good that some litigation is underway, where the SC will finally clarify how it has to be done,” he said, adding that with the high court ruling on RCap expected in 3-4 months, things will become clear. in the aspects of the resolution mechanism.

In the meantime, some supports, such as adjustments to speed up the insolvency process and clarity in regulations to avoid fragmented, biased and unsatisfactory results, could help financial service providers.

“There could be some enabling provisions in the RBI Act to streamline the process in terms of bringing in new promoters and speeding up the process because speed is key,” Chandi said.

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