Test case

| Updated on October 16, 2021

SREI’s resolution, after DHFL, will be seen as a test case on whether IBC can work for financial firms

The Reserve Bank of India’s decision to supersede the Boards of SREI Infrastructure Finance and SREI Equipment Finance and initiate resolution proceedings against them, marks only the second instance where the regulator has used the IBC (Insolvency and Bankruptcy Code) to refer tottering financial firms to bankruptcy court. The IBC had originally excluded financial service firms from its ambit on the understanding that they would need a separate dispensation for resolution with their assets consisting mainly of loans, a fragmented creditor base and ability to trigger systemic risks on collapse. Following the successful resolution of DHFL, all eyes will now be on the SREI resolution as a test case for the future.

DHFL and SREI may appear to have similarities as RBI-regulated NBFCs, but they are quite distinct. DHFL, at the time of its IBC reference, was a pan-India realty lender with nearly half of its ₹90,000 crore loan book comprising retail housing loans. DHFL’s secured mortgage portfolio and its reach into Tier 2 and Tier 3 towns prompted big names such as Piramal to enter the race to acquire it. In SREI’s case though, with the bulk of funds tied up in infrastructure projects and restructured loans, there’s less visibility on recoverability. The slow progress of the IL&FS resolution initiated in 2018 shows the difficulties of untangling the knots when a project financier uses complex holding structures. In SREI’s case, the RBI also appears to have been fighting a battle to clean up the firm’s books for several years now. This paper reported that an RBI-mandated special audit of SREI’s books unearthed negative capital ratios, violations of income recognition and asset classification norms, instances of connected lending and ever-greening even in FY20. The management’s attempts to stymie stakeholders by proposing a scheme of arrangement and NCLT Kolkata’s inexplicable ruling in end-2020 which ordered status quo not just on recovery proceedings, but also on rating downgrades, have rendered recoveries doubly difficult.

The only saving grace to the SREI saga seems to be that, unlike DHFL, it has limited retail liabilities. SREI is a not a deposit-taking NBFC and the bulk of its ₹30,000 crore dues are owed to domestic banks and foreign/domestic institutions, with retail NCD exposures of about ₹1,500 crore. This, coupled with the fact that the group’s debt has carried a low rating for some time, could minimise the systemic impact from its folding up. SREI’s troubles, like DHFL’s before it, serve as a cautionary tale that retail NCDs offering high rates, even if ‘secured’, come with considerable risks to the investor’s principal.

Published on October 15, 2021

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