It has been estimated that the in the Public Sector Banks, the NPAs
percentage can go as high as 17.6% and the same statistics
for Private Sector Banks show that the NPAs may rise up to a level of 8.8 % by
the end of September 2021.
With the second wave of the pandemic in hitting India, it's inexorable to expect
the problem of NPAs/Bad loans to aggravate. After the first lockdown was
imposed, we saw a 'K shaped' recovery pattern which draws a picture that the
outbreak of Covid-19 pandemic in 2020 lead to moratorium being extended to
borrowers by the RBI. The banks were largely uninterested in lending money to
troubled companies.1
At the current economic phase, it is imperative to boost the credit growth to see a healthy recovery on
the economy. On this note, providing troubled companies with interim financing
could
help bolster the struggling economy and presents itself as a very lucrative option for the creditors.
The concept
of interim financing has spread like wildfire with ARCs Companies such as
Edelweiss Asset Reconstruction Company, NBFCs such as Eight Capital LLC, etc. entering the picture. With arms of Private Equity firm likes KKR India also coming forward with Interim financing policies, private
players seem to have the grasp on the interim financing, whereas banks such as
Punjab National Bank and State Bank of India are also slowly coming into the
market with interim financing schemes.2
Research Questions
- What is interim financing and how does it help in increasing the credit flow?
- What makes interim financing a viable option in saving troubled
companies and what effect has the pandemic had on the outlook of interim
financing? And what is its range as an upcoming market for banks and
financial institutions?
- How is the interim financing framework in India and how does it compare
with other framework of other jurisdictions?
- What steps has the RBI taken in order to address the effect of rising NPAs and falling economy on the banking sector and what's the way forward?
Scope
The scope of this projects extends to analyzing the developments in India whilst drawing a contrast with foreign
jurisdictions.
Limitation
Due to paucity of time and resources the gamut of this project has been
restricted to
discussing interim financing under IBC only. An exhaustive analysis of the effectiveness of interim financing and
other viable options could not be done owing to the concept being fairly new and
untested
in the Indian landscape. Also, the issue being present-day, an analysis of the case laws and commentaries could
not be made.
The Impact Of The Pandemic On Banking Sector
The pandemic has rendered economic growth to come to a halt and has led the
economy into an unparalleled recession throughout the globe. The most affected
companies are the ones who already has outstanding debt near the saturation
point. The pandemic has forced India to deploy revised strategies to deal with
the problem of growing bankruptcy of companies which would otherwise triggered
IBC in cataclysmic proportions.
Companies that were already under
liquidity crunch before corona have struggled most due prolonged liquidity crunch also affecting the value of their assets.
Around 1900 companies have been reported to be undergoing CIRP process.
Due to liquidity crunch and downfall in demand, banks' balance sheets have taken a massive blow. Hike
in NPAs have been rising at alarming rates. With the lockdown imposed, shutting
down
of operations of bankrupt companies and dip in demand by prospective bidders alongside depreciating value
of assets, banks have been affected the heavily.3
Even before Covid, the problem of NPAs still existed and in order to mitigate
the issue, the government had already brought into use Corporate Debt
Restructuring Mechanism, Strategic Debt Restructuring Scheme, etc. but to no
avail.
- Bad Banks
Union Budget 2021-22 saw a proposition of setting up of Bad Banks, which is
basically an asset reconstruction company aimed at consolidating stressed
assets. Bad banks basically do the
work of segregating good assets from bad assets and try to resolve these bad assets over some period of time.
This would enable the banks to focus their operating profits on credit growth
and fresh business rather than only limit themselves to making provisions for
bad loans. This lessens the burden of NPAs on the banks. An estimate figure of
around 2.25 Lakh Crore is being made to be transferred to and managed by the bad
banks.
Bank taking over the bad loans helps the banks improve their asset quality at a time when the real lending
rates have taken a hit. At the current economic recovery phase, addressing and
boosting the credit growth is the best idea for the banking industry.
But prior to the bad banks coming into picture, another tool of
solving the boosting credit growth that still exists is interim financing.
What Is Interim Financing?
"
Interim Financing is like oxygen to ailing companies and is indispensable"
Interim financing, also known as rescue financing, is a tool which helps
troubled
companies undergoing resolution proceedings to fund themselves when there's need for funds. It basically is the
raising of any financial debt by the RP (resolution professional) during the
process of insolvency resolution up until approval of a resolution plan by
committee of creditors and the NCLT. Interim Finance is mentioned under section 5(15) of the Insolvency and Bankruptcy Code 20164.
This is super beneficial for the troubled companies and at the same time an
interesting lending opportunity for the creditors.
For a corporate company undergoing the process insolvency, Interim financing has presented itself as
a lucrative option for the company to maintain the status of going concern or
have minimum liquidity to operate. Earlier, there was no provision for accrual
of interest once the liquidation process had started. But now, amendments have
been made and super priority extends to the liquidation process as well.5
While the Corporate Insolvency Resolution Process in underway, there are certain
expenses that the Resolution professional has to make The corporate debtor may
or may not have the funds to cater to the expenses such as payment to staff,
security, fees of valuers and other
professionals. Even for such petty expenses, the RP has to raise funds through interim financing. This raising of funds if subject
to approval by the committee of creditors.
- Features of Interim Financing
Some of the features of interim financing are:
- Interest Rate:
Since interim finance caters to urgent corporate requirements within the CIRP, it is beyond doubt that the creditors will charge higher interest rates. Also, there is
a high risk of timely debt recovery. Creditors charge around 16-24% interest
rates to give out such credit or at an interest which is around 500-600 base
points higher than normal credits.
- Priority status- Section 53 6alongside section 5(3) of the Insolvency
and Bankruptcy Code 7lays down that interim finance takes priority vide
section 53 (1) (a), which implies that they would be the first in line to be
repaid among all the loans in the books of the debtor company. This applies
to both, repayment of principal and repayment of interest on the principal.
- Long term interest- Post the amendment, to the delight of the creditors,
they are now entitled to interest and priority status even post the
commencement of liquidation
- Tenure of Interim finance- Credit extension via Interim financing can
more or less be considered as short term as the loans are extended till the
resolution process is underway or till liquidation. This short-term aspect
of loan extension makes them more secure than long term credits.
- Interim Finance as A Solution for NPA Problem
On a grass root level, the real reason behind piling up of the NPAs is the incaution and indiscretion by
the creditor. RBI as well as the banks, although, mete out credit to the
companies adhering
to the prudential norms, it out of their hands to inspect the corporate/technical decisions taken by the company.
A failure of such debtor company (going bankrupt) go on to the books of the
creditors as bad loans/NPAs. This is where interim finance finds its strength.
It derives its reliability from the security provided by the wisdom of CoC as finance can only be meted out on discretion of the CoC.
In a scenario where the company couldn't survive and is at a liquidation state,
priority is given to the interim finance. Another aspect is that a letter of
comfort can be extended to the lendors by the CoC to undertake responsibility of
security onto themselves. This aspect bolsters the threat of non-repayment
because of the fate of the debtor as CoC also share the burden.
Post the 2020 amendment, provisions were made to raise finance for troubled companies keeping in
mind the current situation of economy during the ongoing pandemic. Section 5(15)
of the Insolvency and Bankruptcy Code has been amended to include "and such
other debt as may be notified" and "during the insolvency
resolution process period" giving freehand to raise
interim finance to the Interim resolution professional and the resolution
professional as and when the requirement surfaces.
It is the duty of the resolution professional to maintain the troubled corporate
debtor as
going concern under section 25 (2) (c) of the Insolvency and Bankruptcy Code8. The resolution professional
also has the power to raise interim finance under the section 5(15) of the
Insolvency and Bankruptcy Code.
The apex court of the country, the Supreme Court has stated in the landmark case of Swiss Ribbons Vs
UOI that "a good realization can generally be obtained if the firm is sold as a
going concern". To this cause, the authority to avail interim finance helps
further the idea of ensuring
going concern status of the corporate debtor even during the CIRP process. In these trying times, interim financing helps the resolution profession/ Interim resolution professional to maintain the necessary cash flow and
liquidity to ensure going concern and mitigate increasing debts9
The setting in India with regards to interim financing was such that the banks
avoided the extending loans to the companies undergoing the process of
insolvency. After a few relaxations extended to the interim finance providers,
the interim finance market had become a lucrative offering for the banks to tap
into.10
Comparing The Insolvency And Super Priority Framework With Other Legislations
In times to come, many companies will file for bankruptcy and the requirement for credit to ensure minimum
liquidity and continuance of operations will increase. This will trigger banks
to
take action in providing credit to such companies for varied reasons. Some may use it as an opportunity to
gain profit from super priority financing and some may lend to safeguards the
position of existing loans.
- Super Priority Financing
Last mile or rescue funding is new concept in India however it's possible to
turn to established jurisdictions such as for example the United States and
Singapore which offer robust financing mechanisms. Analysis of other developed
jurisdictions dictates that super priority status
through express legislative provisions / judicial interpretations should
be granted to the lenders.
- Framework in Foreign Jurisdiction: USA And Singapore
Chapter 11 of the United States Bankruptcy Code 11provides for a super priority
status alongside a lot of other perks to the lendors who
give out credit to troubled companies undergoing reorganization. Such finance
is termed as Debtor in Possession Financing. 12Following the footsteps of USA,
Singapore also made amendments to its insolvency mechanism. Similar to
the US, the Singapore insolvency regime also includes the concept of Debtor in Possession Financing.
Also,
Singapore, in May 2017, amended its company act to introduce section
211E 13which provides for the super priority status of the lendors. One major
hurdle that arises in giving out credit to a troubled corporation is the concern
how the fresh funds would be utilized, would it
be used to siphon off the existing debts or to generate fresh income from it.
To safeguard the creditors in this aspect, the United States Bankruptcy Code provides for a super priority status which implies that
they would be the first in line to be repaid among all the loans in the books of
the
debtor company. This takes care of the debt overhang issue as any cash flow that is generated goes to
repay the Debtor in Possession financer.
The judiciary of Singapore in the
landmark case of
Re Attilan Group ltd laid down the prerequisite conditions that
must be satisfied before the status
of priority is granted to the finance. The finance must satisfy the definition of rescue financing under 211E(9), 14the
finance must have been provided as the last resort in the given
circumstances [section 211E (1)] and the court has discretionary powers to grant
the status of priority.15
"It is only where there is some evidence that the
company cannot otherwise get financing that it
would be fair and reasonable to reorder the priorities on winding up, giving the rescue financier the ability to
get ahead in the queue for assets." The onus lies on the applicant to prove that
reasonable attempt at trying to secure financing has been made while asking for
priority status. In a
scenario where the applicant fails to prove this, priority status will not be granted to the creditor. Singapore has
now introduced a Singapore Bankruptcy Act in 2020.16
The Indian Expirience
The Indian Insolvency and Bankruptcy Code, in order to resolve the issue of
troubled companies undergoing resolution proceedings (CIRP) to raise finance, introduced super priority status under section
5(13)17 in similar lines to the USA and Singapore. In addition to that, post the
2018 amendment, priority status now extends to the creditors during the
liquidation process also. In contrast to Singapore where priority status is
later accorded by the adjudicating authority, the discretion in India lies with
the committee of creditors.
Legislative Framework
Section 5(15) of the Insolvency and Bankruptcy Code has been amended to include
"and such other debt as may be notified" and "during the insolvency resolution
process period"
giving freehand to raise interim finance to the Interim resolution professional and the resolution professional as and
when the requirement surfaces.18
It is the duty of the resolution professional to maintain the troubled corporate
debtor as going concern under section 25 (2) (c) of the Insolvency and
Bankruptcy Code19. The resolution professional also has the power to raise
interim finance under the section 5(15) of the Insolvency and Bankruptcy Code.
Judicial Developments
Certainly, one of 1st cases that addressed the dilemma of Interim Finance
jurisprudence in India is that of Edelweiss ARC v. Sai Regency Power Corporation
Pvt. Ltd and Another20. NCLAT in this case laid down that," Value of a going
concern is much more than a non-functional plant or concern. ‟ implying that
interim finance could be availed for supply of essential goods and
direct costs also.
One caveat that arose from this judgement was that
it failed to ease off the regulations 31 and 32. Regulation 32 puts forth strict
categories of essential goods precluding direct input costs. One of the
intricacies of the judgement was that now a disharmony exists between regulation
31, 32 and Section 14(2A) as it bestows the determining discretion onto the
Resolution Professional and Committee of Creditors.
Legislative Endeavours And The Road Ahead
It is evident that super priority financing in foreign jurisdiction is well
established that works within a well laid and thought-out legal framework which
is specifically cutout to cater to such provisions. Although India in this
aspect is behind the foreign jurisdictions, India too has
taken steps towards bridging the gap through amendments.
A provision was made for the lenders to not lose
out on their ad interim benefits by extending the date till which the interest
could be accrued which was set to 12 months from commencement of liquidation or
loan repayment,
whichever comes first. In another amendment, it was declared that the
asset classification norms would treat interim finance as standard asset while
the power to raise interim finance was extended to the resolution professional.
With India's commitment to promote native indigenous industries to act as fuel
for the
economy, interim financing becomes an important tool in achieving it. With times like these being uncertain, it
is important to have exhaustive guidelines that synchronize with the judicial
and
legislative framework of the country. Had it been done earlier, India could have dealt with the issue of falling economy
during the pandemic in a more efficient manner. Even now, India should endeavor
to evolve into a debt restructuring hub. With the second wave of the pandemic in
hitting India,
it's inexorable to expect the problem of companies slipping down the road of insolvency. 21Prioritizing interim finance during
such times could be a life savior for the troubled companies.
Steps Taken By RBI
RBI has, in order to
bolster the wrath of the pandemic announced various regulatory, supervisory and
monetary measures which include cutting down on interest rates, moratorium on
debt, resolution window within Prudential framework of
stressed asset classification standstill, etc.
To aid the economic revival, the troika of slashing policy rate alongside
liquidity infusion, time bound resolution and regulatory
forbearance was employed by the government.22
WMA (ways and means advances) are basically temporary loan extensions given out to the central government and state government which aid them bridge the gap between revenue and expenditure.
The WMA limit for central government has been set at 2 lakh crores. The limit
set by the RBI to the state under WMA for such credit to 60% enabling the states to be able to borrow an amount
which is estimated to be 51600 crores.
WMA would be able to help in providing enhanced short term liquidity but will
not be the final solution for the nosedive shortfall that was witness in
revenue generation23
The Reserve Bank of India is additionally conducted a $2 billion six-month
sell/buy
The government previously had ordered the banks to not charge interest on
interest on the loans during moratorium period which is estimated to be
around 14000 crores.24
An estimate by the ICRA put forth a figure that the bad loans would've amounted
to 8.7 trillion rupees if the government hadn't intervened. The policy rates
were reduced by 115 base points by the RBI25 Liquidity of around 4lakh crore has
already been infused into the banking system and RBI endeavors to continue doing
that.
RBI has now started the process of unwinding by increasing the cash reserve
requirement to
4% which was earlier at 3% (since the announcement of march 2020). Although it will be a tough task to strike a balance between the unwinding and infusion of liquidity during the recovery process.26
RBI, last year, had announced forbearance to now declare NPAs from March to
August
which proved to be a boon for companies and retailers. This invariably also resulted in resurfacing of the banking asset
quality issue;
The RBI's actions were geared towards providing a boost to the economy whilst
also ensuring financial stability.27
An ordinance was passed on June 5th to forbids the initiation of CIRP which was
extended to
31st March 2021. It suspended section 7,9 and 10 of IBC due to the rising uncertainty and stress in the economy. Now
the companies could not initiate insolvency proceedings.28
Conclusion:
A framework which is well thought-out and in which consultations and viewpoints of all stakeholders
is taken into consideration to effectively protect the interest of every
stakeholder (depositor, lender, debtor, etc.) in the process.
In an attempt to tackle the situation in hand, the government has taken various
measures in the form of reforms to which IBC is no exception. Whilst the economy
had taken a nosedive,
the government was quick to realize the need to save the troubled companies and to take steps to solve the
issue of rising NPAs.
The government increased the triggering threshold for
insolvency, suspended section 7,9,10 of IBC, conducted a $2 billion six-month sell/buy, infused liquidity, etc. in order to bolster the wrath of the pandemic. In short, the government has tried to give extra time and space to companies whilst also ensuring
the best return to lendors after the crisis passes.
One long term viable solution to solve the ever existing crisis of banks, rather
than aiming
to reduce short term burden on sheets of the banks, could be to incorporate "an early warning system" and "forward looking stress testing framework" in risk management framework of the banks.
This would
enable the banks to pick up incipient signals of the debtor's stress and would
also enable them to take remedial actions early and effectively whilst also
ensuring the value of the assets don't go down. In the same landscape, Interim
Financing can be a way which can help save the eroding asset value.
Just like how boosting the immunity and following proper stringent guidelines is
the best way
to tackle the pandemic, to strengthen the banking, financing and debt framework would ensure long term financial
stability.
A framework which is well thought-out and in which consultations and viewpoints of all stakeholders
is taken into consideration to effectively protect the interest of every
stakeholder (depositor, lender, debtor, etc.) in the process.29
Debt restructuring framework should be closely aligned with IBC. Since finance
is an evolving field in the contemporary world and steps have to be constantly
taken towards achieving a synchronous framework. Factors like deregulation,
competition, technological
advancements, globalization, etc. have affected the diversification of operations providing an impetus to financial institutions
extending various service Interim financing in India, being an underdeveloped
field, isn't well regulated and supervised as of now due to the existence of
interim finance under IBC and outside of purview of IBC
which is to say that extension of interim finance is not
just limited to banks or financial institutions30. In this backdrop, the presence of a super regulator might come in handy in dealing with two or more independent regulatory jurisdictions giving rise to supervisory arbitrage.
End-Notes:
- *
- *
- Megha Mittal, Interim Finance Becomes Effective Attractive' (Vinodkothari.com, 2021)
odkothari.com/wp-content/uploads/2019/06/Interim-Finance-Becomes-Effective-Attractive.pdf accessed
7 April 2021
- Insolvency and Bankruptcy Code, §5(15)
- Bhavya Gupta and Arush Agrawal, 'Analysis Of The Insolvency & Bankruptcy
(Second Amendment) Bill, 2020' (The Daily Guardian,
2021) the-insolvency-bankruptcy-second-amendment-bill-2020/> accessed 7
April 2021.
- Insolvency and Bankruptcy Code 2015, §53
- Insolvency and Bankruptcy Code 2015, §5(3)
- Insolvency and Bankruptcy Code 2015, §25(2)(c)
- Coronavirus impact on banks' (The Economic Times 2020)
offering-credit-line-with-softer-terms -to-retail-borrowers /articleshow/74826322.cms?utm
_source=contentonterest&utm _medium=text&utm_campaign=cppst> as accessed
5 April 2021
- A. Gupta, V. Rehan, 'The Going Concern Experiment: Experience With IBC
and Way Forward' 2020 Taxmann.com
/www.taxmann.com/research/search?searchData=2020%5D%C2%A0122%C2%A0taxm ann.com%C2%A0269%C2%A0(Article)> accessed
1 April 2021
- US Bankruptcy Code 2015, Chapter 11
- United Nations World Economic Development Report
://www.un.org/development/desa/dpad/document_gem/global-economic-monitoring-unit/world- economic- situation-and-prospects-wesp-report/>
accessed on 01 April 2021
- Companies Act Singapore, §211E
- Companies Act Singapore, §211E(9)
- Vantage Editor, 'Rescue Financing: Helping Hand For Entities In Distress
| India Business Law Journal' (Law.asia,
2021) distress/accessed
1 April 2021.
- Singapore Bankruptcy Act 2020
- Insolvency and Bankruptcy Code 2015, §5(13)
- Insolvency and Bankruptcy Code 2015, §5(15)
- Insolvency and Bankruptcy Code 2015, §25(2)(c)
- Edelweiss Asset Reconstruction Company v. Sai Regency Power Corporation Pvt.
Ltd and Anr, [2019] Comp. App. (AT) (Ins) No. 887 of 2019.
- RBI Says Banks Need To Prepare For Challenges After Unwinding Of Covid-Related
Measures (BloombergQuint, 2021) www.bloombergquint.com/economy-finance/banks-need-to-gear-up-to-meet-new-challenges-following-unwinding-of-measures-to-combat-covid-rbi> accessed 7 April 2021.
- Anup Roy, 'Covid-19: In Fight Against Economic Slowdown, RBI Introduces New
Measures' (Business- standard.com, 2021) ://www.business-standard.com/article/economy-policy/rbi-introduces-measures-to-fight-covid-19-slowdown-cuts-repo-rate-to-3-75-120041700485_1.html> accessed 7 April 2021.
- Ibid.
- Japnam Bindra, 'RBI States Waiver Of Interest Would Risk Financial Stability Of The Banks' (mint, 2021) www.livemint.com/industry/banking/moratorium-case-rbi-states-waiver-of-interest-would-risk-financial- stability-of-the-banks-11591217084160.html> accessed 7 April 2021.
- Shaktikanta Das, 'It is Time for Banks to Look Deeply Within: Reorienting
Banking Post-Covid' (Speech at Unlock BFSI 2.0, 27 August 2020)
- Supra note 1
- Sushant Hede, 'One Year Later, What Changes Should We Expect In The RBI'S
Pandemic Playbook?' (The Wire, 2021)
accessed 7 April 2021.
- Vivek Kaul, 'What Today'S Supreme Court Order On Loan Moratorium Means For Banks' (mint, 2021) www.livemint.com/industry/banking/what-today-s-supreme-court-order-on-loan-moratorium-means-for- banks-11616504216224.html> accessed 7 April 2021.
- RBI Says Banks Need To Prepare For Challenges After Unwinding Of Covid-Related
Measures' (BloombergQuint, 2021)/www.bloombergquint.com/economy-finance/banks-need-to-gear-up-to-meet-new-challenges-following-unwinding-of-measures-to-combat-covid-rbi> accessed 7 April 2021.
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