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Why the IBC is not the best bet in resolving distressed assets

Factors such as low recovery rate, longer timeline for recovery, and high incidences of liquidation are making the IBC a bridge to nowhere for banks and financial institutions

August 05, 2021 / 09:41 AM IST

Even five years after the Insolvency and Bankruptcy Code (IBC) became a law of the land, it is sad to see that the resolution of distressed assets through the due process of the law has not made any notable progress. The IBC looks like a bridge to nowhere when it comes to the central issue of recovering stranded loans at fair value. Massive haircuts — the amount that lenders have to forego on their outstanding loans with interests — and inordinate delay in arriving at a meaningful resolution process agreed by all stakeholders make it even less attractive for financial institutions.

Despite several amendments to the law and the ground-breaking judgments of courts to settle contentious debt disputes, delays and low recovery rate continue to plague the IBC regime. Data talk volumes about the drawbacks of the IBC. Recently, the regulator Insolvency and Bankruptcy Board of India (IBBI) released a dataset that sheds light on the recovery and resolution of assets through it.

There were 348 cases of insolvencies successfully resolved as of March 31. Banks and financial institutions (FIs) recovered around Rs 2 lakh-crore out of the total claims of Rs 5.16 lakh-crore, taking a haircut of over 60 percent on an average. This includes some large companies such as Essar and Bhushan Steel. If we remove these large cases, the haircuts taken by banks would come out to be much more. Moreover, in Q4 FY’21, 29 insolvency cases were resolved with creditors recovering Rs 4,600 crore out of total claims of Rs 17,389 crore — that’s a paltry 26.45 percent recovery rate.

The average time taken to resolve the cases is 459 days, which is much more than the stipulated 180 days. Time and again, concerns have been raised over the high percentage of liquidation after companies failed to get viable plans. For instance, 1,277 of the total 4,376 companies undergoing insolvency proceedings have been liquidated so far. That is 30 percent of all cases.

From the globally followed practice of debtor in possession — except in the United Kingdom — we are now moving to the concept of creditor in possession. The IBC leaves the responsibility of managing the asset in the hands of a resolution professional (RP), who, in all probability, has low-to-no experience in running industrial units or domain expertise.

Due to the long gestation period for resolving cases under the IBC, the assets have to undergo a widespread lack of alignment with business interest. This has led to a downward spiral in the value of assets over a period of time until the case is resolved or liquidated. Add to this the legal and administrative cost. These activities have resulted in erosion in the value of assets adding to lender's costs. The funding cost for acquisition under the IBC has been prohibitive where the expected IRR (internal rate of return) for investors ranges anywhere between 20-24 percent.

This, too, leads to lower recovery value for the lenders since potential investors would discount the future cash flows at 20-24 percent resulting in lower net present value (NPV) since there is hardly any domestic capital available in the segment.

This is not to say that the IBC has lost its relevance. A suggestion is to enable bankers to make economically-efficient decisions. This calls for arriving at fair competition by allowing existing promoters to bid for their assets unless somebody is proven guilty of fraud and siphoning of money for personal use.

Technical disqualification may entail wilful default which is flagged in cases such as utilisation of funds for short to long term, or vice versa, or putting pressure on borrowers to regularise the account. However, this may be easier said than done since bankers — especially from the public sector — may not take a call on such thorny issues as they fear any future inquiry poses a threat and increases complications after their superannuation.

On the other hand, promoters should believe in the merits of forgoing control of their failing business in the wider interest of the economy. They not only help the recovery of sticky loans by financial institutions, but also help reorganise the business as the new promoters will necessarily have to pump in fresh capital with management competency. Lenders will also open fresh credit lines to the business in question.

Factors such as low recovery rate, longer timeline for recovery, and high incidences of liquidation are making the IBC a bridge to nowhere for banks and financial institutions.

Nirmal Gangwal is Managing Partner, Brescon & Allied Partners LLP. Views are personal and do not represent the stand of this publication.
Nirmal Gangwal
first published: Aug 5, 2021 09:39 am