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Extend pre-pack insolvency resolution process to all borrowers: RBI’s M Rajeshwar Rao

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Lenders should not wait for a default by a borrower to initiate resolution processes, according to Reserve Bank of India Deputy Governor M Rajeshwar Rao. He said it may be worthwhile to consider extending the pre-packaged insolvency resolution process to all borrowers,

He observed that it is necessary to continue improving the regulatory regime for out-of-court resolutions through suitable harmonisation of the regimes across various classes of regulated entities as well as periodic review of the Insolvency and Bankruptcy framework to keep pace with the changes in the economy and financial system.

“A modern insolvency law such as the IBC (Insolvency and Bankruptcy Code) deserves support and patience from all stakeholders and the attitude towards the new piece of law should not be influenced merely by losses materialised in respect of resolution of assets that have been stressed for long,” Rao said in his recent address at the International Research Conference on Insolvency and Bankruptcy held at IIM Ahmedabad

The Deputy Governor noted that various classes of lenders are governed by disjoined set of out-of-court resolution frameworks that applies separately to each class of lender.

“Without participation of all lenders, any effort towards resolution is likely to be incomplete and would be a mere postponement of the inevitable reckoning. The time lost in pursuing such incomplete resolutions is likely to compound the eventual losses to the creditors and costs to the financial system,” he said.

Referring to delays in admission of insolvency applications, Rao said while the Code prescribes a period of 14 days as the time taken between filing of an insolvency application and the eventual admission of the application, but in reality, the admission usually takes a much longer time than that.

A consultation paper released by the IBBI on April 13, 2022, notes that average time taken for admission of an insolvency application by an operational creditor has increased from 468 days in 2020-21 to 650 days in 2021-22.

“This is longer than even the stipulated deadline for completion of a CIRP (Coprorate Insolvency Resolution Process) under the Code. Such delays in admission are likely to reduce the efficiency of IBC as a comprehensive bankruptcy law and may weaken the creditor rights and ease of exit for bankrupt borrowers,” the Deputy Governor said.

Extend pre-pack to all borrowers

Rao observed that the new dimensions being introduced to the IBC such as the new module of the pre-packaged insolvency resolution process (PPIRP/pre-packs) which combines the best of the out-of-court resolution efforts and the judicial finality of a resolution plan approved by an Adjudicating Authority are welcome initiatives.

“Even though PPIRP has been presently allowed only for borrowers that are classified as micro, small and medium enterprises, we could envision pre-packs as a natural complement to the Prudential Framework of RBI in respect of all borrowers in that difficult resolution involving non-cooperative lenders can be resolved using such pre-packaged plans. It would be worthwhile to consider extending PPIRP to all borrowers,” he suggested.

The Deputy Governor emphasised that group resolution process is especially vital in an economy like India where traditionally credit contracts have been embedded with cross obligations and credit mitigating covers provided by parent and group companies of the borrower.

In such a system, a default by a borrower is likely to spur cross defaults by group companies thereby increasing the overall credit risk to the financial system. A comprehensive process for collective resolution of such interlinked corporate groups is thus necessary to further improve the efficacy of the Code, he said.

Rao underscored that lenders should combine prudent risk pricing of their exposures with ongoing monitoring of the exposure and maintenance of adequate capital and risk provisions.

Additionally, since the point at which a counterparty has become insolvent cannot be pinpointed accurately, the risk management practices of the lenders have to be sophisticated enough to capture the changes in risk factors that may affect the safety of the said credit exposure.

“Lenders should also perform periodic stress tests to estimate possible trajectories that the credit exposure is likely to take and calibrate their responses accordingly.

“Ultimately, they are responsible for safeguarding their own interest and interest of their stakeholder,” he said.

Published on May 07, 2022

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