Rajeshwar Rao: Strengthening the Insolvency and Bankruptcy Code
(IBC) framework for effective resolution
Inaugural address by Mr Rajeshwar Rao, Deputy Governor of the Reserve Bank of
India, at the International Conclave, jointly organised by the Insolvency and Bankruptcy
Board of India (IBBI) and INSOL India, New Delhi, 7 December 2024.
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Good Morning Ladies and Gentlemen.
At the outset, I would like to thank Shri Ravi Mital, Chairperson, Insolvency and
Bankruptcy Board of India for inviting me to this international conclave on the theme
'Insolvency Resolution: Evolution & Global Perspective' being held in collaboration with
INSOL India. A confluence in the thought processes of policy makers, practitioners and
academicians would perhaps help to shape an objective assessment of the resolution &
insolvency regime in the country. This should then enable us to chart out a future path
for the resolution processes to make it more effective and efficient.
Today, let me begin by reflecting on the role of Insolvency and Bankruptcy Code (IBC)
in cleaning up of banks' balance sheets and on the possible ways we could further
leverage its potential for the key stakeholders from our perspective, viz. the financial
creditors. The present insolvency and bankruptcy regime in India was the outcome of
the suggestions made by the Bankruptcy Law Reforms Committee headed by Dr. T K
Viswanathan. The Committee's recommendations for the new insolvency and
bankruptcy resolution system were based on a few core principles namely (i) facilitating
the assessment of viability of the enterprise at an early stage; (ii) enabling symmetry of
information between creditors and debtors;(iii) ensuring a time-bound process to better
preserve economic value; (iv) respecting the rights of all creditors, with clarity on
priority; and (v) ensuring finality of outcomes.
The outcome of the action on these recommendations was the Insolvency and
Bankruptcy Code (IBC) of 2016. The code and its related ecosystem have continued to
evolve since then, effectively advancing the principles mentioned above. However, its
implementation being a function of the broader ecosystem in which it operates, the
code has faced various criticisms in its relatively short existence, particularly regarding
delays in meeting timelines and unsatisfactory recovery rates, partly due to the
misaligned incentives amongst the stakeholders. While several amendments have been
made to the IBC since its introduction to address some of these concerns, challenges
persist.
Role of IBC in cleaning up of bank balance sheets
As you are aware, asset quality position of the banking system has shown a remarkable
improvement over the past few years - specifically, the gross NPAs of the scheduled
commercial banks have declined from the peak of 11.2% in March 2018 to 2.8% in
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March 2024 . A good part of that reduction is attributable to resolution processes
enabled under IBC. If an overall assessment of IBC is made, it shows a significant level
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of traction as a resolution mechanism. As of September 2024, 8,002 cases have been
admitted into the Corporate Insolvency Resolution Process (CIRP) and approximately
75% of these cases were closed through resolution, withdrawal, review, settlement, or
liquidation. Of the closed cases, 56% were either resolved, settled, or withdrawn. In a
positive trend, the ratio of resolutions to liquidations has risen from 21% in 2017-18 to
61% in 2023-24. In addition to facilitating resolution outcomes, the IBC has also been
effectively used by both financial and operational creditors to encourage borrowers to
repay their debts. By March 2024, 28,818 cases involving an outstanding default
amount of 10.22 lakh crore were withdrawn prior to admission.
In terms of the powers vested under newly inserted Section 35AA of the Banking
Regulation Act, RBI had issued directions to banks in 2017 in respect of 41 entities,
which accounted for more than 35% of the banking system NPAs at that point, for filing
CIRP applications. So far, resolution plan has been approved in the case of 17
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borrowers , orders of liquidation have been issued in the case of 12 borrowers,
settlement was reached by lenders with 2 borrowers; and in 4 cases the lenders have
assigned their exposures to ARCs. The aggregate realisation for financial creditors from
the 17 resolved cases has been around 50% of admitted claims and 190% of liquidation
value.
Financial creditors are now actively leveraging the Code for resolution of stressed
assets. As of September 2024, around 633 corporate debtors, where insolvency
application was initiated by financial creditors, have been successfully resolved under
IBC, yielding an average realization of 30.09% of admitted claims. Further, CIRP
applications filed by financial creditors in 702 corporate debtor accounts have been
either resolved through appeal/review/settlement or withdrawn under section 12A.
Similarly, liquidation orders have been passed in respect of 1224 corporate debtors.
Moreover, the operationalisation of section 227 of the code in 2019 empowered
Reserve Bank to leverage the IBC mechanism for resolution of Financial Service
Providers (FSPs). Reserve Bank has used this avenue for initiating insolvency
proceedings against four FSPs so far and all of them have been successfully resolved
as on date. Evidentially, IBC seems to have played a significant role in cleaning up the
bank balance sheets.
Although the IBC has proven to be a valuable tool for creditors, its full potential has
been realized only to a limited extent. Let me elaborate on some of the factors that have
constrained its effectiveness to give a clearer understanding of why the IBC's potential
has not been fully harnessed.
(i) Delay in initiation
Time and Timing are both crucial for the effectiveness of the resolution process. While
delays within the IBC process have been widely discussed, an equally important issue
is the delay in initiating the IBC process itself. The IBC grants all creditors the right to
initiate the CIRP upon default. However, in practice, the average time taken by financial
creditors from the date of default to the filing of the CIRP is often several months. A
significant amount of value is lost during this period, which ultimately impacts the
recovery outcome. In this context, the role of financial creditors is vital-they must take
prompt action to prevent further value erosion.
While IBC has gained prominence of late, we need to realise that it is just one amongst
the host of mechanisms available for creditors to resolve financial stress. There are
other statutory mechanisms for enforcing security, as well as out-of-court workout
options for resolution, each with its own role and limitations. From a regulatory
perspective, the Reserve Bank remains neutral regarding the mechanisms chosen by
lenders, as long as the actions are initiated in a timely manner so as to facilitate the
prompt resolution of financial distress.
(ii) Efficacy of out of court workouts
The real success of a formal insolvency framework lies in its role as a deterrent than
based on its actual use. It is out of court workout procedures that need to work as the
primary instruments of resolution, albeit under the shadow of the formal insolvency
framework. In the Indian context, the RBI's Prudential Framework on Resolution of
Stressed Assets provides a viable out of court workout mechanism. This Prudential
Framework provides a broad principle-based regime for early recognition of stress and
time-bound resolution by the lenders. However, the efficacy of this mechanism has
been constrained on account of several factors, including issues with coordination
among lenders. What is therefore required is a mechanism to bridge the principle-based
resolution approach under out of court workout with that of the statutory umbrella of IBC
so that a resolution initiated out of court can be transitioned and get implemented under
IBC.
Recognising this requirement, the Pre-Pack Insolvency Resolution Process
(PPIRP/prepack) was introduced in 2021, aimed at resolution of micro, small and medium sector
enterprises (MSMEs), as an alternative to a regular CIRP. The Pre-pack was envisaged
to be a panacea for MSMEs as it had all the ingredients to make a successful resolution
recipe: debtor in possession, cost-effective, quicker resolution timelines and base
resolution plan prepared by the MSME itself. Under the pre-pack arrangement, the
MSMEs and creditors have to reach a prior agreement to resolve, before formally
entering into pre-pack insolvency process. Despite all the advantages, only ten
applications have been admitted under PPIRP so far, out of which one was withdrawn,
and resolution plans has been approved in five cases.
The IBBI had established an Expert Committee, which submitted its report in May 2023
on the Creditor-led Resolution Approach under the Insolvency and Bankruptcy Code,
2016. The report suggests converting the current fast-track process under the IBC into
a 'creditor-led' and 'out-of-court' insolvency resolution process, similar to the PPIRP, but
with key modifications to address challenges observed in the adoption of PPIRP. A
suitable framework could be adopted in this regard that would be aligned with the
intended objectives without undermining the essence of the IBC.
(iii) Role of Committee of Creditors (CoC)
The IBC assigns a central role to the Committee of Creditors (CoC) in the CIRP.
However, this is an area where significant improvements are needed. There have been
instances where the CoC's performance has been found lacking in several aspects.
These include disproportionate prioritization of individual creditors' interests over the
collective interest of the group; disagreements among CoC members on approving a
resolution plan due to concerns over undervaluation or perceived lack of viability;
disagreements on the distribution of proceeds even when a resolution plan is agreed
upon; non-participation in CoC meetings and lack of effective engagement,
coordination, or information exchange among members. Instances have been noted
regarding insufficient skill sets in areas like corporate finance, legislation, and industry
knowledge; and, lastly, the nomination of financial creditors to the CoC are entrusted
with responsibilities that far exceed their actual authority.
It is in the larger interest of the creditors that the issues relating to the conduct of the
CoC are addressed by the members themselves without waiting for regulatory
prescriptions or fiats. However, it is a fact that when incentives are not perfectly aligned,
deviations from best practices become the norm. Therefore, we need an enforceable
code of conduct for the CoC. Obviously, it would not be possible for the sectoral
regulators to enforce this given the diverse set of financial creditors. Ideally, the IBBI,
which is the designated regulator under the IBC, should have the powers to enforce
norms around the conduct of all stakeholders under the IBC process.
(iv) Role of the Resolution Professional
Another key stakeholder under the IBC ecosystem is the Resolution Professional (RP)
whose expertise and proficiency materially impacts the outcome of the resolution
process. The resolution professional should have thorough knowledge of the industry,
the business environment, laws in force and should also be adept at financial analysis
and management of distressed firms. The aspect of management is very critical here as
the RP takes control of the distressed corporate debtor and virtually discharges the duty
of the MD/CEO, based on the advice of the CoC. Any shortcomings in the selection and
in the action of the RP would be a significant impediment in the process. The code
implicitly and explicitly casts lot of operational responsibilities on the RP ranging from
collation of claims to finding prospective resolution applicants to providing material
inputs to CoC for finalising the resolution plan. However, in many instances, the RP do
not enjoy the cooperation of other stakeholders, which impairs the ability of the RP to
discharge its duties satisfactorily. It is heartening to note that that IBBI has taken steps
to facilitate the training of RPs through the continuing professional education (CPE)
programs, trainings, workshops, webinars, and seminars. These steps together with
better enforcement of conduct related regulations would go a long way in addressing
these issues.
(v) Incentivising resolution professionals
Regulations can set the boundaries for an activity but cannot cover every detail. While
regulations have helped create an ecosystem for Resolution Professionals (RPs), their
compensation should be determined by the market based on commercial
considerations. RPs step in after all attempts to resolve the issue by the debtor and
creditors fail, and they take on the important task of managing the debtor's affairs.
Managing a corporate debtor under insolvency proceedings requires specialized skills.
The market should develop compensation structures for RPs that are tied to the
outcomes of the resolution process. This would address the principal-agent issue and
align the RP's goals with the CoC, maximizing value for both parties. It would also
attract experienced professionals, benefiting the system as a whole.
Way Forward
It has been nearly eight years since the introduction of the code and several large
cases have been successfully resolved under the code. Quality data is being
generated, out of the insolvency process, which could be used in future as inputs for
credit underwriting as well as valuation.
The IBC eco-system would not be complete if it cannot provide a feedback loop to the
real economy through a review of experience in resolution or liquidation. A detailed
study of enterprises placed under the insolvency process can provide valuable insights
if we compile data from such cases. Currently such data is not compiled systematically
and is disaggregated, mostly concentrated with individuals based on their experience
and exposure. If this data is collected and institutionalised through a structured process,
it can give us valuable insights and precedents on how to proceed in complex cases.
Such data therefore needs to be gathered in a structured manner so that it can be
disseminated for the benefit of all stakeholders involved.
Leveraging Data-
There are few key areas that could be explored further to improve the overall resolution
ecosystem. First, a better understanding of the reasons behind defaults-whether this is
on account of the general economic environment, specific industry challenges, or
professional mismanagement. This perspective can help to tailor appropriate solutions.
Second, addressing the delay resulting from lack of cooperation by some corporate
debtors in the insolvency process, such as delay in submitting information, withholding
valuable details, using litigation to stall progress, or creating indirect obstacles to
discourage potential resolution applicants, is crucial. Finally, examining valuation,
including insights on how collateral types affect realization versus valuation, the impact
of time on recovery, and the relationship between resolution timelines and valuation
outcomes, could provide us with information which can help us to improve the process.
Perhaps better valuation at the time of appraisal is the key. Often the disparity in
valuation between the appraisal and the resolution stages is indicative of over
exuberance in valuation and possible lack of appropriate due diligence.
-and Technology
With the rise of technology, the payment ecosystem has undergone significant
transformation. Fintech service providers are using technology to gain insights into
consumer behaviour through the vast payment data generated. Some progress has
been made in using technology for loan underwriting, particularly for small borrowers
and MSMEs, through cash flow-based models. The next step should be for banks and
other stakeholders to use technology to help resolve issues with stressed borrowers.
The technology should focus on several key areas like predicting defaults before they
happen based on the borrower's data, enabling early corrective action; analysing both
structured and unstructured data to identify related party or preferential transactions,
saving resources for lenders and resolution professionals; automating routine tasks in
post-disbursement credit monitoring, freeing up time for lenders to focus on more
complex issues; and reading legal documents and contracts to provide valuable insights
for the CoC and resolution applicants when valuing the corporate debtor. As technology
and its application evolves on these fronts, there could be significant reduction in effort
involved as well as costs associated with the resolution.
Conclusion
I would like to close my remarks with few parting thoughts! It is possible that bankruptcy
or liquidation proceedings may be the only way for the company to revive and start
afresh. We should, however, look to restructuring and revival of units as the first option
and enable it in a quick and time bound manner. There are valuable assets vesting
within an enterprise that we as a nation can ill afford to run doing even though as
creditors the liquidation process appears as the safer and risk free option. For this it
may be necessary to create an ecosystem that encourages revival of the enterprises.
While IBC 2016 remains a landmark legislation, that has fundamentally altered the
landscape of corporate practices in the country, the onus is on us to ensure that
collectively, we harness the potential of the code to create a thriving ecosystem which
enables value preservation.
In our journey to improve the resolution frameworks, let us not only look at the
perceived obstacles or the roadblocks but also look back at the path we have traversed
so far and the learning's along the way. We need to think of measures which can make
the code an effective option for unlocking economic value of an enterprise even as we
ensure strict enforcement of the provisions of the code in case of recalcitrant or
unscrupulous borrowers. The last decade has been a journey of learning,
improvements, and growth for all of us who are stakeholders in this process as
Regulators, financial institutions or as borrowers. This Conclave should bring out fresh
insights as to how to unlock the potential of the Code which will serve to strengthen the
financial system, so that it plays its role in fostering a robust growth for our nation.
Thank you and Namaskar.
1
RBI Supervisory returns
2
Data referred to in this Speech in respect of various aspects of cases referred under
IBC has been compiled from IBBI Quarterly Newsletters
3
Data compiled by RBI from concerned banks