Did RBI drag its feet on $4-bn SREI crisis?

Has the Reserve Bank of India’s (RBI) decision to supercede the boards of SREI Infrastructure Finance and SREI Equipment Finance citing governance concerns and defaults by the two companies come too late in the day? There seem to be differing views among financial sector experts and resolution professionals.

According to Care Ratings, the debt of the two companies exceeds ₹29,000 crore (around $4 billion), with dues from SREI Infrastructure Finance to lenders and other creditors pegged at ₹11,828 crore and that of SREI Equipment Finance at over ₹17,400 crore.

To begin with, RBI had flagged off lending to probable related parties by SREI group of companies in its inspection and risk assessment report for the year ended March 31, 2020. In fact, SREI was directed by the regulator to reassess and factor in the impact of certain parties during the finalisation of the balance sheet for FY21, and provide relevant accounting treatment and appropriate disclosures. Following which, the company had to provide for credit loss provisions of ₹4,685 crore and additional provisions of ₹4,475 crore under the income recognition and asset classification norms.

In fact, a report by independent auditor D.K. Chhajer & Co had raised concerns about the ability of SREI Infrastructure Finance to continue as a going concern. The report had pointed out that the group's net worth had eroded and it had failed to comply with regulatory ratios and limits, thereby impacting the group’s “ability to continue its operations in the normal course in the future and meet its financial commitments as and when due."

“What prompted RBI to take corrective action when a special audit had already pointed out a problem in the books, and the regulator knew there were governance issues?” a leading resolution professional (RP) told Fortune India.

Though the financials were qualified by the auditor, SREI had said both group companies planned to raise significant capital with SREI Infrastructure board passing a resolution to raise up to ₹2,500 crore through either a public offer, QIP, preferential or rights issue. But the plan did not fructify.

Besides the Kanorias, Hemant and Sunil, there are five independent directors, including Punita Kumar Sinha, on the board of SREI Infrastructure Finance. RBI has superceded the board citing “governance issue” and appointed Rajneesh Sharma, ex-chief general manager, Bank of Baroda, as the administrator of the aforesaid companies under Section 45-IE (2) of the RBI Act. Besides, the central bank has constituted a three-member advisory panel comprising R. Subramaniakumar, former managing director and CEO, Indian Overseas Bank; T.T. Srinivasaraghavan, former managing director, Sundaram Finance, and Farokh N. Subedar, former chief operating officer and company secretary, Tata Sons, to assist the administrator. The resolution process will be conducted under the provisions of the Insolvency and Bankruptcy Rules (Financial Service Provider Insolvency and Liquidation Proceedings and Enforcement), framed in 2019.

In Q1 FY22, SREI Infrastructure had reported a consolidated net loss of ₹971 crore, against a profit of ₹23 crore a year ago, and net loss of ₹3,555 crore in the previous (January-March) quarter. “There has been no meaningful business that the two NBFCs were engaged in since the crisis began. Also by prolonging immediate action, the quality of books would have deteriorated as well. RBI could have pre-empted action much before bankers reported their exposure as NPAs,” says the RP quoted above.

However, according to a financial sector expert, it would be wrong to blame the central bank. “As a regulator, it has to follow a process… they will have to justify the step that they take. Just because the NPA of the entity has gone up you cannot supercede the board. You will have to see what message it sends to the industry as a whole. An entity can be moved into insolvency at the first signs of challenge only when the stress becomes too high and the existing management cannot turn over the situation. Then only the regulator has to step in….you cannot say the last step has to be the first step,” says the head of a rating agency.

Last December, the Kolkata bench of the National Company Law Tribunal (NCLT) had issued an order stating that any non-payment by SREI will not be considered as an event of default, till a scheme of arrangement is signed by all creditors. But last month, the tribunal set aside its earlier order. “Something that is sub-judice with the NCLT would not have made it appropriate for the regulator to come into the picture,” adds the head of the rating agency.

In the case of Yes Bank, the lender had superceded the board in March 2020, three years later after the first sign of distress came to light in 2017 when RBI said its bad loans were more than the bank had divulged. But in this case, following the inspection of the bank’s books, the central bank denied an extension to its founder and chief executive Rana Kapoor.

The SREI referral is the second instance where RBI has initiated insolvency proceedings against a non-bank lender. In November 2019, the central bank had referred Dewan Housing Finance Corp. to the IBC and only last month, the Piramal group wrapped up the transaction for ₹34,250 crore.

Even as the debate heats up around RBI’s moves, the company, too, has issued a statement: “We are shocked by RBI's move as banks have been regularly appropriating funds from the escrow account they have controlled since November 2020. Moreover, we have not received any communications from banks on any defaults….We will take all necessary steps as advised by our lawyers in this regard.”

Looks like another protracted legal wrangle is in the offing.