Insolvency

Insolvency refers to the inability of a person or corporate to pay up his debt/bills as and when they become due.
He may be able to pay at a later date some amount or even in full, but at the promised date of payment, he is unable to make the payment.
Insolvency leads to the state of default.

Bankruptcy

Bankruptcy is the next state of insolvency where an individual and partnership firm is declared by the relevant authority under a specified law for the purpose, as incapable of paying up his debt/bills at any time in present as well as in the foreseeable future.
Generally, failure of resolution process leads to bankruptcy.

Liquidation

Liquidation is the winding up of a corporation or incorporated entity under the supervision of a person or liquidator, empowered under law for such operation and for distribution of proceeds to the various creditors as per an agreed formula.
Only firms can be liquidated.
Defaulting individuals cannot be liquidated.

Solvency Ratio

Measure of an enterprise’s ability to meet its debt and other obligations.
The solvency ratio indicates whether a company’s cash flow is sufficient to meet its short-term and long-term liabilities.
The lower a company's solvency ratio, the greater the probability that it will default on its debt obligations.

Classification of NPA

Net NPA = Gross NPA - provisioning
Increase of loss in increasing order

Standard Asset

Special Mention Accounts - Early detection of stress can be here

SMA 0 - if principal/interest not paid from 1-30 days
SMA 1 - if principal/interest not paid from 31-60 days
SMA 2 - if principal/interest not paid from 61-90 days

As multiple lenders reporting SMA for same company, JLF Joint Lenders Forum is formed

NPA

Principal/Interest over due by 90 days
For agri loans, over due by a crop season

Substandard asset

NPA + >= 12 months

Doubtful asset

Substandard + >= 12 months

Loss asset

When Bank/RBI/Auditor says
Loss/ no salvage value

Stressed assets = NPA + Restructured assets + Written off assets

Agricultura NPAs

Generally, principal or interest due for over 90 days is considered as NPA. But this principle is not applicable to Agricultural Loans
A loan granted for short duration will be treated as NPA if the instalment of principal or interest thereon remains overdue for two crop seasons. For longer duration crops, it is one crop season
Rise in NPAs in Agricultural sector because

Rural distress
Decreased landholding
Implications of farm loan weaver (wilful loan default)
Using loan amount for other purposes
Decreased global prices for farm commodities

Measures to reduce NPA

The Government has taken sector specific measures (Infrastructure, Power, Road, textiles, Steel etc.) where incidence of NPA is high.

Recovery of Debts due to Banks and Financial Institutions (RDDBFI) Act 1993

Debt Recovery Tribunals (DRTs) 1993 for improving recovery established under the Recovery of Debts due to Banks and Financial Institutions (RDDBFI) Act 1993 have been amended to improve resolution/recovery of bank loans.

Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest Act (SARFAESI) 2002

Empowers banks to seize/mortgage the underlying securities in case of defaulter.
Banks can take possession/lease/sale/manage those securities
Banks cannot hold attached assets for more than 7 years but can sell to ARC companies
Applicable to Housing finance companies
Agricultural loans are exempted
In Budget 2016, provisions of SARFESAI extended to NBFC which are more than 500 crore turn over and can seize loans more than 1 crore. Implies that NBFC can seize.
Cooperatives also empowered to recover assets under SARFESI act except agri loans
Disputes settlement under Debt Recovery Tribunals DRT and further appeal to Debt Recover Appellate Tribunals DRAT

The Insolvency and Bankruptcy code (IBC) 2016
Banking Regulation (Amendment) Act 2017

Empowered RBI to direct banking companies to resolve specific stressed assets by initiating insolvency resolution process, where required.

Companies (Amendment) Act, 2017

to issue shares at a discount to its creditors, for excess salaries take permission from creditors

RBI has provided a number of tools in this regard-

Corporate Debt Restructuring (CDR), - 2001, 2008,2013

Feb 2018, RBI withdrawn this scheme to be substituted by better harmonized scheme post IBC

Formation of Joint Lenders’ Forum (JLF),

Feb 2018, RBI withdrawn this scheme to be substituted by better harmonized scheme post IBC

Flexible Structuring for long term project loans to Infrastructure and Core industries (5/25 Scheme) - June 2014

For infrastructure and 8 core industries
extended loan periods by 25 years
adjusted interest rates every 5 years so as to match the funding period with the long gestation
Feb 2018, RBI withdrawn this scheme to be substituted by better harmonized scheme post IBC

Asset Restructuring Companies ARC - August 2014

They were introduced under SARAFAESI Act 2002.
This lets bank focus on its core activities and ARC solving debt problems.
But ARCs have only been able to buy 5% of the total NPAs over 2014-2015. They have found it difficult to recover from the debtors

Strategic Debt Restructuring Scheme (SDR) - June 2015

Loans of company can be converted into Equity and thereby of equity more than 50%, can change ownership
Under this the banks can take over firms and sell them to new owner
Not successful because of shareholders permission required to change loans from debt to equity
Feb 2018, RBI withdrawn this scheme to be substituted by better harmonized scheme post IBC

Asset Quality Review Scheme - October 2015

It is a financial inspection conducted by RBI in 2015-16.
It checks whether the banks have classified assets correctly according to loan repayments
Its loan sample size was larger than an annual financial investigation conducted by RBI.

Sustainable Structuring of Stressed Assets (S4A) - June 2016

An independent agency hired by banks decides how much unsustainable debt can be converted to equity. No permission of shareholders required unlike SDR
Unlike SDR it does not have change of company’s ownershipProjects with a loan of at least Rs 500 crores and have commenced commercial operations are eligible to be restructured under S4A.
How it works

Banks can split the overall loans of struggling companies into sustainable and unsustainable based on the cash flows of the projects.
The unsustainable debt could be converted into equity or a convertible security. [Preferential shares without voting power]
However at least 50% of the debt should be serviced in the same period as that of the existing loan. [Hence no change of ownership][In case of SDR, ownership can be changed]
Once the unsustainable debt is converted to equity, banks can sell this stake to a new owner who will have the advantage of getting to run the business with a more manageable debt.

Feb 2018, RBI withdrawn this scheme to be substituted by better harmonized scheme post IBC

Feb 2018, RBI new guidelines 'Resolution of Stressed Assets – Revised Framework'

Early identification and reporting of stress

Special Mention Accounts - Early detection of stress can be here

SMA 0 - if principal/interest not paid from 1-30 days
SMA 1 - if principal/interest not paid from 31-60 days
SMA 2 - if principal/interest not paid from 61-90 days

Lenders shall report credit information, including classification of an account as SMA to Central Repository of Information on Large Credits (CRILC) on all borrower entities having aggregate exposure of > 5 crores
Lenders shall weekly report all such borrowing default entities information to CRILC

Implementation of Resolution Plan

All lenders must put in place their Board-approved policies for resolution of stressed assets under this framework, including the timelines for resolution
Resolution plan (RP) may involve any actions / plans / reorganization including, but not limited to, regularization of the account by payment of all over dues by the borrower entity, sale of the exposures to other entities / investors, change in ownership, or restructuring
As soon as there is a default in the borrower entity’s account with any lender, all lenders − < style='text-decoration:underline;font-family:"Nirmala UI";font-size: 12.0pt;background:yellow;mso-highlight:yellow'>singly or jointly − shall init ate steps to cure the default.
If the resolution plan involves restructuring or change of ownership of accounts of more than 100 crore then an independent credit evaluation (ICE) of the residual debt will be done by the credit agencies appointed by RBI. Whereas the accounts with exposure of 500 crore and above will require two ICEs.

Implementation conditions for Resolution Plan

Resolution plan is said to be implemented only if

the borrower entity is no longer in default with any of the lenders;
if the resolution involves restructuring; then

all related documentation, including execution of necessary agreements between lenders and borrower / creation of security charge / perfection of securities are completed by all lenders; and
the new capital structure and/or changes in the terms of conditions of the existing loans get duly reflected in the books of all the lenders and the borrower.

Applicable to accounts where resolution process has already been initiated under any of the RBI schemes as well as the accounts classified as restructured standard assets.
Not applicable to the accounts where insolvency action has already been initiated under the insolvency and bankruptcy code.

Timelines

Timeline for large accounts more than 2000 crore

Resolution plan for all stressed cases of above 2000 crores must be completed within 180 days from the date of first default

If the default done before March 1, 2018, then the reference date is taken as March 1, 2018

If not with in time, then referred to IBC

For accounts b/w 100 - 2000 crore

timeline for implementation o resolution plans will be announced over a two year period.

Other features

All accounts, including such accounts where any of the schemes (SDR, 5/25, S4A etc) have been invoked but not yet implemented, shall be governed by the revised framework.
Borrowers who have done fraud and willful default will not be eligible for restructuring.
If the lenders do not adhere to the timelines for resolution process, tries to conceal the status of accounts or indulge in ever greening of stressed assets, then they will face strict actions will be taken by the RBI against them which may extent to imposing monetary penalties also.

CRILC (Central Repository of Information on Large Credits) is responsible for collecting, storing and disseminating credit data to banks on credit exposures of Rs. 5 crore and above

banks will have to furnish credit information to CRILC on all their borrowers having aggregate fund-based and non-fund based exposure of Rs.5 crores and above.

Prudential Framework for Resolution of Stressed Assets (PFRSA)

By RBI in June 2019
Early resolution of stressed assets
Complete discretion to lenders with regard to design and implementation of resolution plans
Disincentives for delay in implementation of resolution plan or initiation of insolvency proceedings,
Mandatory the signing of an inter-creditor agreement, providing for majority decision-making by all lenders

Project Sashakt

Aim: To strengthen the credit capacity, credit culture and credit portfolio of public sector banks.

It is a five-pronged strategy towards resolution of stressed assets as recommended by Sunil Mehta Committee

Loan exposure up to Rs.50 crore	Loans between Rs.50 crore and Rs.500 crore	Loans above Rs.500 crore
Small and Medium Enterprise (SME) resolution approach	Bank-led resolution approach	AMC/AIF led resolution approach
A resolution plan will be arrived at within 90 days of detection of stress by individual banks.	Resolution led by consortium of lenders needs to be completed within 180 days else referred to National Company Law Tribunal for insolvency proceedings
Resolution plan will be based on simple metrics and Standard Operating Process (SOP)	Resolution plan will be led by a Lead Bank appointed among the lenders consortium by the banks through Inter-creditor agreement	Loans would be resolved through an independent Asset Management Company which would be funded by Alternate Investment Fund AIF. AIFs can also bid for assets in NCLT
Internal SME Steering panel would be established by the banks to validate these schemes including provisioning of additional funds	Independent Steering Committee appointed by Indian Banks Association has to validate the process within 30 days
	Resolution Plan has to be approved by voting by lenders holding atleast 66% of the debt	The price discovery of these NPAs will be through open auction by the lead bank in which asset reconstruction companies (ARCs), AMCs and other investors can participate

4. NCLT/IBC approach

If any of the above 3 options fails, IBC Insolvency and Bankruptcy Code may be invoked.

5. Asset-trading platform

To be created for trading of both performing and NPAs

Note:

5/25 scheme is applicable only to core industries and infrastructure
SDR vs S4A

Under SDR, ownership can be changed but under S4A, ownership cannot be changed
Under SDR, stakeholders permission required for restructuring debt while under S4A, no permission required.

Asset Reconstruction Companies are established under SARFESAI act

Twin Balance Sheet Problem TBS

Balance Sheet summarizes the assets and liabilities of any individual/institution at any time
Twin Balance sheet (TBS) problem is a two fold problem:

Overleveraged companies

A company carrying too much debt and unable to pay interest payments from loans

Bad loan with banks

Loan repayments to banks are ‘past due’ their time, turning to Non-performing assets

Causes:

Increased debt of companies during high growth times
Delay in projects execution

Environmental and land clearances were difficult to get, causing delays. This made debt go bad.

Global Financial Crisis (GFC) 2007-2008 that reduce growth and reduced revenues
RBI increased interest rates to avoid inflation, increasing the financing costs sharply.

Indian TBS is unique. Though high NPA, decent growth because majority of NPA is with PSB (66%) which has sovereign state backing which attracts investors. High NPA in other countries led to crisis but not in India
Can TBS is sustainable ?

Can be Sustainable under two scenarios

Phoenix scenario - Improved cash flows to stressed companies make it revived and can service debts
Containment scenario - Increased GDP growth in large scale makes the NPAs minuscule. Though the problem not solved

Insolvency and Bankruptcy Code 2016

For early identification of financial distress and timebound resolution of insolvency and bankruptcy cases by Insolvency professional
IBC consolidates various laws, regulations and rules concerning and classifies insolvency, bankruptcy and liquidation of non-financial entities, systematically and comprehensively. Since a ‘Code’ is a compendium of laws, thus, becomes a code, than just being a law
Applicable to companies/limited liability entities/individuals
How it works

If a company/individual is default - insolvent/bankrupt
Appointment of an Insolvency Professional
Moratorium period 280/270 days
Credit committee formation
Committee will try to chalk out a resolution plan under 5/25, SDR, S4A scheme
If the plan is approved by 75% of creditors, plan will be implemented
Else the asset goes to liquidation

Initiation
Liquidator- Liquidator shall form an estate of assets, consolidate, verify and determine the value of creditors claims

Distribution of assets in the order

Insolvency related costs
Secured creditors and workmen dues upto 24 months
Other employee's salaries/dues up to 12 months
Financial debts (unsecured creditors)
Government dues (up to 2 years)
Any remaining debts and dues
Equity (first preferential sharehold ers, then others)

Insolvency Professionals IP

These IPs will be members of insolvency professional agencies (IPAs).
Licensed
Ex: Indian Institute of Insolvency Professionals of ICAI

Adjudication structure

Companies - National Company Law Tribunal
Individuals - Debt Recovery Tribunals

Insolvency and Bankruptcy Board of India IBBI

Statutory body established under IBC 2016
Objective

To supervise, monitor and frame guidelines for enforcement of IBC 2016
To oversee and regulate Insolvency Professionals, Insolvency Professional Agencies, Information Utilities.

Structure

Chairman
One RBI nominated official
Three ex-officio members from Ministry of Law, Finance, Corporate Affairs
5 nominated members (minimum 3 member full time)
Total 10 members including chairman
All term 5 years or 65 age. Eligible for reappointment

It also has provisions to deal with cross border insolvency

Information Utility IU

It is an information network which would store financial data like borrowings, default and security interests etc. of firms.
Objective - to provide high-quality, authenticated information about debts and defaults.
It is mandatory for financial creditors to provide financial information to the information utility. Hence, database and records maintained by them would help lenders in taking informed decisions about credit transactions.
Information Utility are governed by the Insolvency and Bankruptcy code 2016 and IBBI (Information Utilities) Regulations 2017
National e-Governance Services Ltd (NeSL) became India’s first information utility (I ) for bankruptcy cases under the Insolvency and Bankruptcy Code 2016.

India's IBC is presented as an Example by World Bank in its Ease of Doing Business report for efficacy of law in insolvency
IBC vs SARFESAI Act

SARFAESI Act, 2002 covers only secured financial creditors while IBC protects the rights and interests of both secured and unsecured creditors
IBC adjudication authorities are NCLT and DRT while SARFESAI adjudication authorities are DRT

Insolvency and Bankruptcy Board of India (Insolvency Resolution Process for Corporate Persons) Regulations, 2016,

Insolvency and Bankruptcy Board of India (Fast Track Insolvency Resolution Process for Corporate Persons) Regulations, 2017

As per the Amendments, it is not necessary to disclose ‘liquidation value’ in the Information Memorandum.

Insolvency and Bankruptcy Code (Amendment) Ordinance 2018

Home buyers will be treated as financial creditors and have the right to be represented in the Committee of Creditors
Related party - now includes both Companies and individuals (earlier only companies)
Vote share changes

Vote share	Before	Now
Appointment of Insolvency Professional	75%	66%
Other decisions	75%	51%
Process can be withdrawn by		90%

Exemptions to MSME sector

Promotors and guarantors of the MSMEs are exempted from disqualification from bidding
It further empowers the Centre to allow further exemptions or modifications w.r.t. the MSME sector

Moratorium from parallel proceedings will not be available to guarantors of the company
If a financial creditor is a related party to a company facing insolvency, it shall not have any participation or voting during a meeting of the Committee of Creditors (CoC)
A company can file an insolvency application, provided it seeks shareholders’ approval an at least three fourth of the stakeholders approve the proposal

Dissenting Financial Creditor

According to amended Regulations, dissenting financial creditor means a financial creditor who voted against the Resolution Plan or abstained from voting for the Resolution Plan, approved by the Committee of Creditor
Resolution Plan also needs to identify specific sources of funds to be used for paying the liquidation value due to dissenting creditors

Insolvency and Bankruptcy Code	FRDI
Individual/Company/Limited Liability entities	Financial firms
Distribution of assets in the order Insolvency related costs Secured creditors and workmen dues upto 24 months Other employee's salaries/dues up to 12 months Financial debts (unsecured creditors) Government dues (up to 2 years) Any remaining debts and dues Equity (first preferential shareholder s, then others)	Order of priority under liquidation Deposit Insurance Resolution costs including liquidation costs Workmen dues for 24 months and Secured creditors Wages to employees for 12 months Uninsured deposits and insurance related amounts Unsecured creditors Govt remaining dues and remaining secured creditors Remaining debt and dues Shareholders
Insolvency Professional Liquidator	Resolution Corporation Liquidator
National Company Law Tribunal Debt Recovery Tribunal

Recapitalisation bonds

Bonds created for recapitalization are called Recapitalisation bonds
How it works

The government will issue bonds (instead of money) to the banks for a share of the bank’s Equity.
The annual interest on these bonds and the principal on redemption will be paid by the central government.
These bonds can be sold off by the banks in the market when in need of capital.

Significance

The government need not raise immediate tax revenues to fund the mounting bill on bank recapitalisation, which means less burden on the taxpayer

Does Recapitalisation bonds be included in the Fiscal deficit?

As per Chief Economic Advisor, under IMF accounting, they are not included in the Fiscal deficit
However, being cash neutral transaction, fiscal deficit will only be impacted by the interest cost on the bonds that the government pays every year. May not have effect on inflation

Non-Performing Assets NPA