Can a Resolution Corporation Set Failed Financial Firms Straight?

The pandemic has resulted in higher non-performing assets and capital erosion, resulting in causing stress and failure in many banks and non-banking financial companies (NBFCs). As a remedy to this situation, the governor of Reserve Bank of India (RBI), Shaktikanta Das, has proposed the establishment of a resolution corporation. The concept of resolution corporation was initially a part of the Financial Resolution and Deposit Insurance Bill, 2017. It was later withdrawn.

During the seventh SBI Banking & Economics Conclave, Das expressed that such a corporation has the potential to ensure that the financial firms do not end up being liquidated. He added that the depositors could get a better value in the resolution of a bank rather than when the bank goes for liquidation.

Traditionally, a failed bank would be merged with a larger bank. Though this approach protects depositors’ interest, it would bring down the statistics of the balance sheet of the larger bank. Therefore, Das suggested developing a new approach with legislative backing to set up a resolution corporation that can deal with the resolution and revival of stressed financial firms.

When it comes to NBFCs and housing finance companies (HFCs), RBI reserves the right to take over the administration of such privately-held entities under Section 227 of the Insolvency and Bankruptcy Code (IBC). Consequently, RBI has all the power to appoint an administrator to the failed entity, Dewan Housing Finance Corporation Limited.

Also Read: RBI Proposes Relaxation in MHP for Mortgage-based Securities

Not just appointing an administrator to a failed financial firm, RBI also has to pay close attention to the workflow and stay vigilant. It also has to send out warning signals and flag the emerging risks. Das mentioned that they are focusing on identifying issues at their root level and taking corrective measures.

They are also looking at interacting with the management of the financial firms, asking them to take necessary steps to prevent issues, replacing key personnel, and preparing for additional liquidation.

The pandemic has created stress for banks and NBFCs, leading them to a situation where they need to raise capital. The situation has called for a recapitalisation plan with Public Sector Banks (PSBs) and private banks in mind. Though NBFCs’ situation seems sorted, a close eye needs to be kept on the redemption pressure that may build up on NBFCs and mutual funds.

With the possible damage in mind, the regulator has called for banks and NBFCs to assess the impact of COVID-19 on their respective balance sheets, asset quality, profitability, liquidity, and capital adequacy for FY2020-2021. Based on the outcome of this stress test, the entities will have to come up with a mitigation plan, including capital raising, capital planning, and contingency liquidity planning.

For any clarifications/feedback on the topic, please contact the writer at apoorva.n@cleartax.in