Curious Case Of Huge 'Haircut'

There has been a steep rise to 73 per cent in haircuts to creditors in the financial year 2023-24 (FY24) compared to the previous fiscal year when the haircut stood at 64 percent, as highlighted in a recent note by Icra.

An Asset Reconstruction Company (ARC) is a specially designed financial institution that purchases non-performing assets (NPAs) or bad loans from banks and other financial institutions. This allows the selling institutions to clean up their balance sheets, as the ARCs take over the burden of dealing with these bad loans.

Understanding Haircuts
A ‘haircut’ in financial terms typically refers to the reduction applied to the value of an asset. In the case of financial creditors, a haircut refers to the reduction in the value of a loan they have given out. For example, if a borrower proposes to pay only Rs 27 on a Rs 100 loan, and the lender accepts this, it means the lender has taken a 73 per cent haircut.

Challenges in the CIRP Process
In the press note, one of the primary reasons mentioned for this exponential rise in haircuts is the increase in the average duration for closing a corporate insolvency resolution plan (CIRP), which was 843 days in FY24 compared to 831 days in FY23.
“Nonetheless, we continue to find creditors approaching the National Company Law Tribunal (NCLT) to admit a defaulting corporate debtor with substantial delays, which results in significant erosion of assets,” said Abhishek Dafria, Senior Vice President and Group Head of Structured Finance Ratings at Icra. Dafria mentioned that there is an acute difficulty in closing the CIRPs in a time-bound manner, on account of litigations by the promoters or dissenting creditors as well as overburdened NCLT benches. “This contributed to a worsening of the haircut that the creditors had to take through the IBC process to a steep 73 percent in FY24, from the already high cut of 64 percent, seen in the preceding fiscal,” Dafria said.

Exposure of Banks to the NCLT
The exchange filing reveals that 75 accounts of Punjab National Bank have been exposed to the NCLT, accounting for Rs 6,431 crores. UCO Bank has 289 accounts exposed to the NCLT, which sums up to Rs 18,489 crores. The amount exposed by Indian Bank is Rs 21,881 crores with 243 accounts exposed to the NCLT, whereas Canara Bank has Rs 40,976 crores exposed to the NCLT with its 375 accounts. There are 306 accounts of Bank of India totaling Rs 32,072 crores with the NCLT.

Accounts Referred to the National Asset Reconstruction Company (NARCL)
On the same line, the Union Bank of India has 17 accounts amounting to Rs 2,098 crores that have been referred to the National Asset Reconstruction Company (NARCL). UCO Bank has 13 accounts in total amounting to Rs 2,020 crores with NARCL. Punjab National Bank has Rs 6,814 crores from its 28 accounts to the NARCL. From the available information, Indian Bank tops the chart with 40 accounts with a total of Rs 8,442 crores referred to NARCL.

Lack of Specific Exposure Data from Other Banks
It is also worth mentioning that the analyst presentation of State Bank of India, Bank of Maharashtra, Central Bank of India, Punjab & Sind Bank, Bank of Baroda, Indian Overseas Bank, and most of the private sector banks have not mentioned the specific amount of their exposure to the NCLT.

Review of Insolvency and Bankruptcy Code
The standing committee on finance, in its thirty-second report on the implementation of the insolvency and bankruptcy code pitfalls and solutions, has stated, “The Committee believes that the design of the code needs to be reviewed, taking into account the lacunae and roadblocks that have surfaced in implementing the code so far so that the very purpose behind its enactment is not defeated. The process of admitting claims also needs to be revisited as huge delays occur at this stage, creating a domino effect on the whole resolution process and, most critically, degeneration of asset value.”

Resolution vs Liquidation Ratio
According to the latest data available from the Insolvency and Bankruptcy Board of India (IBBI), the ratio of the number of cases ending with resolution and the cases in which liquidation is offered has improved from 0.46 in FY23 to 0.61 during FY24. The NCLT passed liquidation orders for 446 corporate debtors in FY24 against 400 corporate debtors in FY23. The number of CIRPs that have resulted in liquidation continues to be significantly high, at around 45 percent of the 5,467 closed CIRPs, since the inception of IBC, according to the press note by Icra.
Only 17 percent yielded a resolution plan, with the remaining cases withdrawn post-NCLT admission. As of March 2024, the press note mentioned that liquidation for 960 corporate debtors had been completed wherein the creditors realized a paltry 4 percent of their total admitted claims.

Admitting Entities Under IBC
Dafria emphasized, “The objective for admitting an entity under IBC is not to recover the claims through liquidation, but for most cases, there has been no other alternative, either due to lack of bids or low valuations submitted by the bidders.” Dafria further mentioned that more than 75 percent of the CIRPs that entered into liquidation had been defunct entities or were already under the Board of Industrial and Financial Reconstruction (BIFR) at the time of admission under the IBC. “This again demonstrates the need for creditors to approach the NCLT benches to resolve defaulting entities sooner to have a better chance of keeping the entity as a going concern,” he pointed out.

RBI's Stance on ARCs
Recently, while addressing 27 ARCs, Swaminathan J, Deputy Governor, RBI, has said, “ARCs need to adopt a regulation plus approach where there is compliance with both the letter of the regulation and also its spirit. Boards should accord due importance to assurance functions, namely, risk management, compliance, and internal audit. These functions play a critical role in identifying and mitigating risks, ensuring compliance with laws and regulations as well as safeguarding the organisation’s reputation.”

Similarly, Rajeshwar Rao, Deputy Governor, RBI, stressed the need for responsible conduct in the recovery process and emphasized that ARCs should follow transparent and non-discriminatory practices in line with the comprehensive fair practice code (FPC) put in place by the Reserve Ban

Sheikh Rishad

BW Reporters The author is a Trainee Correspondent with BW Businessworld