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Resolution under Insolvency and Bankruptcy Code may be limited: Moody's

Abhijit Lele/Mumbai 20 Jun 17 | 01:38 AM

Global rating agency Moody’s has said the effectiveness of a resolution under the Insolvency and Bankruptcy Code (IBC) is expected to be limited as the existing management may continue to play a role even after transferring control to insolvency professionals. 

Once a resolution under IBC is initiated, control of the company shifts from the existing management to insolvency professionals. Nevertheless, given the nature of the assets, the management team in some cases will continue to play a role in preserving day-to-day operations.

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In addition, the strict timelines of a resolution may force some companies into liquidation and may have a negative effect on banks, particularly in cases where little collateral is available, the rating agency said in a statement. 

Last Wednesday, the Reserve Bank of India (RBI) announced plans to resolve the troubled loans of 12 large borrowers responsible for about 25 per cent of the banking system’s non-performing assets (NPAs). Some of these 12 accounts relate to borrowers in the steel, power and other infrastructure sectors such as engineering, procurement, and construction contractors. These cases will be referred to the banks concerned, to be dealt with under IBC. "This is credit positive for India's banks because any meaningful resolution under this plan can help improve their overall asset quality. Additionally, it also will set a precedent for resolving non-performing loans from smaller borrowers," Moody's said in a report. RBI has asked banks to also review other NPAs and finalise a resolution plan over the next six months.

RBI’s action plan follows an NPA Ordinance, passed last month, which provides the central bank greater legal authority to intervene in NPA resolutions. The timelines to resolve a case under IBC are strict with a maximum period of 270 days (initially 180 days, with a one-time 90-day extension). After this, a company will be automatically liquidated. This directive will significantly expedite the resolution process and will help in loan recoveries.  

Indian lenders’ asset quality has significantly deteriorated over the years, although the pace of deterioration has somewhat moderated in recent quarters. In addition, despite multiple measures from RBI and the government, banks have had limited success in resolving stressed assets, given an overall weak operating environment.

They have also limited the capacity of many banks to absorb losses from a write-down that may need to be taken for a resolution, Moody’s said.

RBI is yet specify the provisioning norms. But, the directive will negatively affect banks’ profitability over the next year if they need to take large write-downs relative to their existing loan-loss reserves for those assets. This will also accentuate the capital needs of weaker public sector banks, which may require a large capital infusion from the Indian government. 

The negative effect will be somewhat manageable for rated private sector banks, given their strong profitability and capitalisation. 

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