One of the existing policies and practices that needs urgent attention is stressed asset management through the Insolvency and Bankruptcy Code (IBC) of 2016. It is beset with multiple concerns best exemplified by the abysmally low “recovery”. It touched a new low in December 2023 when the National Company Law Tribunal (NCLT) approved the resolution of bankrupt Reliance Communications Infrastructure Ltd (RCIL) for just ₹455.92 crore – less than 1% of “the claimed” debt of ₹49,668 crore and “the admitted claims” of ₹47,251.34 crore.

This is worse than it appears at first glance because the IBC “resolution” (different from “liquidation”) is not just about debt recovery but revival of a bankrupt firm. Hence, a few questions arise: What happened to the assets? What happened to the collaterals or personal guarantees the loans would have entailed?

The focus here is on a worrisome trend the causes of which need to be studied and fixed. After all, high haircut isn’t new. A parliamentary panel had, in 2021, expressed serious concerns about “disproportionately large and unsustainable” haircuts going up to “as much as 95%”, asked the Centre to fix a “benchmark” and sought review of “the design and the implementation” of the IBC.

That the panel’s advice has not yet been heeded is bad enough. Worse, the IBC seems to enjoy wide and largely uncritical support from the power-that-be after the RCIL resolution.

Defending the indefensible?

On January 11, 2024, RBI Governor Shaktikanta Das said at an event that the IBC’s performance “appears quite encouraging”, arguing that the “resolution value” (recovery) should be compared with “liquidation value” or “fair value” at the time of admission since by the time a firm was admitted under the IBC “significant value destruction” would have already happened. He noted, by those yardsticks, the IBC had done well with the realization of 169% and 86%, respectively.

A few days later, on January 15, 2024, former chairman of the IBBI (IBC regulator) MS Sahoo (2016-2021) wrote (i) the recovery “is not an objective of the IBC” and “is not mentioned in the legislation”, rather (ii) the objective “is resolving stress” and that it achieved this as 5,000 firms had exited, out of 7,000 that entered the IBC process. He also wrote that the IBC (iii) “penalises attempts to use the IBC for recovery” but didn’t explain how or why (iv) dismissed high incidence of “liquidation” arguing that the IBC allowed “the market to make the choice” and said (v) three-fourths of the firms liquidated were “either sick or defunct”.

The only issue both Das and Sahoo flagged is the long delay in the IBC process.

Chief Economic Advisor V Anantha Nageswaran followed this with “The Indian Economy: A Review”, released on January 29, 2024. It had only good things to say: (a) the IBC had “rescued 808 corporate debtors” with realisations of 168.5% against “the liquidation value” and 32% against “the admitted claims” and (b) cited a study by IIM-Ahmedabad (August 2023) which had found 76% rise in average sales, 50% rise in average employee expenses and 50% rise in average total assets of the resolved (“resolution”) firms. This report had also been cited by Sahoo.

The ’white paper’, tabled on February 8, 2024, mentioned the IBC for its positive impacts on FDI inflows and bank balance sheets.

How fair is “fair value”?

All the above claims and arguments hide more than they reveal.

One, “liquidation value” is not the right yardstick in “resolution” cases – which is about reviving bankrupt firms through takeovers. It is relevant only in “liquidation” cases (the other outcome of the IBC when “resolution” fails).

Under the IBC, both “liquidation value” and “fair value” are carried out by outside agencies. This is a sound business practice but needs a closer look. For example, the cumulative IBBI data up to September 2023 shows, such valuations are abysmally low for the 808 firms which had successful “resolution”: “Liquidation value” at 18.9% and “fair value” at 29.5%, respectively, of “the admitted claims” (debts) for these firms. Hence, the high recovery against these parameters. The IBBI reports are silent on the assets of those firms.

Valuation of firms has attracted attention for all the wrong reasons so far.

It came to public debate during the first privatisation of nine CPSUs during 1999-2003. The CAG’s 2006 report flagged how high-value assets like land, plant and machinery, operational and reserve mines, fully developed township and power plant (in the BALCO, Modern Bread and others) were excluded from valuations. One of these, the sale of Hindustan Zinc Limited (HZL) in 2002, came back to haunt in November 2021 when the Supreme Court ordered fresh CBI investigation. The court discovered that “unknown public servant” had appointed the valuer; the valuer “didn’t possess the requisite expertise”, “failed to consider” various assets (including several mines and mineral reserves) and the global advisor on valuation was missing (“undergone voluntary liquidation”). The story of the privatisation of the Central Electronics Limited (CEL) and Pawan Hans Ltd (PHL) in 2022 and 2023, respectively, was no different and undervaluation was one of the reasons for termination of their sales.

Two, delays do cause “significant value destruction” but this needs to be fixed, not used as an argument to justified low recovery. “Value destruction” due to delays can happen in three ways. One is delay in approaching the IBC – which may cause to asset stripping – is counter-intuitive because the RBI mandates banks and NBFCs (“Prudential Framework for Resolution of Stressed Assets” of 2019 and also 2021) to classify and report NPAs if the interest payment is overdue by 90 days (a reversal of its 2018 directive to do so after a day’s default the context is explained later).

The second way is delays in the IBC process and asset stripping – both of which are known. The IBBI data reveals, “in 808 resolved CDs” (resolved cases), 200 applications of “avoidance transactions” worth Rs 1.13 lakh crore (another phrase for asset stripping) are pending with adjudicating authority (AA) as on September 30, 2023 – which is a reflection of systemic failure (to prevent money laundering, asset sales and timely action/decision).

The third is poor due diligence in giving loans (without verifying the assets, collaterals/personal guarantees), followed by poor monitoring of debtors (check against money laundering, assets stripping etc.).

Three, the IBC’s preamble says it is meant for “time-bound” resolution “for maximisation of value of assets”, “promote entrepreneurship”, “availability of credit” and “balance the interests of all the stakeholders”. If “recovery” is sub-optimal, none of the other IBC objectives would succeed. Hence, the argument that recovery “is not an objective” of the IBC makes no sense.

Four, the IIM-Ahmedabad study’s finding is inevitable because of abysmally low valuations of firms (liquidation and fair values) and very high haircuts.

Poor outcomes of IBC

Here are the other key (cumulative) outcomes of the IBC up to H1 of FY24:

(i) 808 firms were “resolved”, leading to “recovery” of 31.9% of “the admitted claims”.

(ii) 2,249 cases (74% of all the IBC’s 3,057 cases) ended in “liquidation” (junk sale), yielding 4.9% of “the admitted claims”. 77% of liquidation cases (1,713 of 2,229 for which data is available) “were earlier with the BIFR” (pre-2016) – pointing to a massive failure of the IBC.

(iii) Total recovery (resolution plus liquidation) is 16.7% – a haircut of 83.3% against 75% haircuts under the much-maligned BIFR.

(iv) "Delay” in the IBC processes range from 414 to 867 days for “resolution” and 426 to 857 days for “liquidation” cases (against stipulated period of 180 days and maximum allowed period of 270 days).

Multiple systemic risks to IBC

There are many systemic threats to the IBC.

The Centre diluted the IBC in 2021 when it brought “Pre-Packaged Insolvency Resolution Process (PPIRP)” for MSMEs – which takes the stressed assets of MSMEs to outside the IBC mechanism. This also means moving away from the creditor-driven resolution framework of the IBC to the debtor-driven one (like in the case of BIFR) – by allowing debtors to run the business while the resolution is on. This is a reversal of the 2021 parliamentary panel’s call to further strengthen the creditors’ rights (“the fundamental aim of this statute (IBC) is to secure creditor rights”). Nothing is known about the PPIRP’s progress.

This happened after the Centre diluted the RBI’s regulatory powers in 2018. It came immediately after the RBI issued a “revised framework” asking banks to start resolution process after a day’s default. Then RBI Governor Urjit Patel resigned soon thereafter and flagged it in his 2019 book “Overdraft: Saving the Indian Saver”, stating that the Supreme Court had found nothing problematic with the RBI framework. He had also flagged how many Central ministers had publicly criticised the IBC. The same year, then Deputy Governor of RBI Viral Acharya wrote a book “Quest for Restoring Financial Stability in India”, also accusing the Centre of diluting the IBC (“…forbearance in loss recognition crept in again for some asset classes; and the resolution of several non-performing borrowers under the Insolvency and Bankruptcy Code was stayed”).

The RBI’s “Prudential Framework for Resolution of Stressed Assets” of 2019 and also 2021 mentioned earlier – which mandates banks and NBFCs to classify and report NPAs after corporate entities default by 90 days.

To make matters worse, the IBC seems to have been gamed. A good example of this is a progressive fall in the “recovery” (cumulative) from “resolution”: 70% in FY18, 43% in FY19, 46% in FY20, 39% in FY21, 33% in FY22, 32% in FY23 and 32% in H1 of FY24. This could be for a variety of reasons – cartelisation, official favouritism, low bidder interest or something else – which elaborate studies can establish.

Then there are related issues that need scrutiny and course corrections to make the stressed asset resolutions successful:

· Corporate structures have become increasingly complex to detect money laundering and assets stripping – multiple layers of interconnected firms with shell companies and tax havens (Panama Papers, Paradise Papers and Pandora Papers).

· Conflict of interest and poor standards of auditing by the Big 4 (recall the Satyam Computers and IL&FS cases). More recently, the National Financial Reporting Authority (NFRA) flagged deficiencies in Big 4 and their associates.

· Private bad banks, the ARCs, are under scanner. After raiding four of them at 60 places in Mumbai, Delhi and Ahmedabad in December 2021 the Income Tax Department revealed this about those: (i) “unholy nexus” with loan defaulters in which “a maze of” shell companies were involved (ii) acquired NPAs at “far less than the real value of the collateral securities” (iii) “usually” took money from defaulters to pay banks and “more often than not” stressed assets were “re-acquired” by defaulters “at a fraction of their real values” (iv) “concealed the profits on disposal”, thereby “evaded” tax and “deprived” the banks their share of actual profits and (v) maintained “a parallel set of accounts” containing “cash transactions” of more than ₹850 crore and funds were routed through “offshore structures (tax havens) to acquire the assets”. More than two years later, the RBI is yet to cancel their licenses.

· Public sector bad bank NARCL (set up in 2021) is handicapped as public sector bankers are reluctant to transfer NPAs to it. Multiple newspaper reports said in January 2024 that this was because the NARCL offered lower than the liquidation value. The Rajya Sabha was told on December 12, 2023 that as against a target of ₹2 lakh crore, only ₹11,617 crore of NPAs had been transferred until November 30, 2023. The RBI’s banking trend report of 2022-23” shows PSBs account for the least NPAs sold to ARCs and NARCL. In a meeting with PSBs on December 30, 2023, Sitharaman directed them to improve transfer of bad loans to the NARCL and also prevent banking frauds (another big concern).

· Evergreening of loans by PSBs? This became the talking point first in 2020 when the RBI-appointed KV Kamath Committee recommended this (called “Resolution Framework for Covid19-related Stress”) in 26 sectors due to the pandemic stress and the RBI accepted. In May 2023, the RBI Governor revealed that PSBs had found “innovative ways to conceal the real status of stressed loans” but days later in June 2023, the RBI offered “compromised settlement” with fraudsters and willful defaulters and made them eligible for fresh loans after 12 months.

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