Insolvency & BankruptcyStreamlining Insolvency Resolution for Financial Service Providers

Introduction

Financial service providers (FSPs), including banks, Non-Banking Financial Companies (NBFCs), insurance companies, and other regulated financial institutions, play a critical role in the stability and growth of the Indian economy. Their unique functions—involving public deposits, payments, credit intermediation, and safeguarding investor interests—necessitate a distinct resolution framework when these entities face financial distress.

The Insolvency and Bankruptcy Code, 2016 (IBC) was pioneering legislation that streamlined insolvency for corporate debtors. However, due to the systemic importance and sensitivity of financial firms, the IBC initially excluded FSPs from its scope. Recognizing the challenges in resolving stressed financial firms, the Government, in consultation with regulatory authorities like the Reserve Bank of India (RBI), introduced special insolvency provisions through the FSP Rules in 2019.

More recently, discussions around further amendments aim to streamline insolvency resolution for financial institutions, ensuring continuity, protecting the public interest, and facilitating timely and orderly resolution. This article explores the evolution, key provisions, and timelines governing the insolvency resolution for FSPs in India, highlighting the unique challenges and the legal architecture designed to preserve the stability of the financial sector.

Historical Background and Regulatory Framework

Exclusion of FSPs from the Original IBC

Under Section 3(8) of the IBC, FSPs were initially excluded from the definition of a ‘corporate debtor’. This exclusion was a deliberate measure to avoid the potential disruptions to the financial system that ordinary insolvency proceedings could cause, thereby protecting depositors and policyholders.

Section 227 and the FSP Insolvency Rules

Section 227 of the IBC empowers the Central Government, in consultation with the relevant financial sector regulators, to notify specific categories of FSPs for insolvency and liquidation proceedings under the Code. Exercising this power, the government issued the Insolvency and Bankruptcy (Insolvency and Liquidation Proceedings of Financial Service Providers and Application to Adjudicating Authority) Rules, 2019 (FSP Rules).These rules apply a tailored insolvency regime to notified FSPs, primarily addressing:

• Timelines adapted for the complexity of financial firms.
• Protection of critical functions such as deposit-taking and payment settlements.
• A crucial supervisory role for sector regulators (e.g., RBI).
• Measures for the continuity and orderly management of financial services.

Key Special Provisions for FSPs

Applicability and Eligibility

The FSP Rules apply to FSPs specifically notified by the Central Government, typically those whose failure could pose a systemic risk to financial stability. For instance, certain NBFCs with significant asset sizes have been notified, with the RBI acting as the “appropriate regulator”.

Other categories of FSPs, such as insurance companies, remain outside the IBC’s direct purview and are governed by their respective sectoral resolution frameworks until a specific framework under the IBC is notified for them.

Resolution Authorities and Timelines

While the National Company Law Tribunal (NCLT) serves as the adjudicating authority, the resolution of FSPs involves close collaboration with sector regulators. These regulators provide vital oversight to ensure financial stability is maintained throughout the process.

The timelines under the FSP Rules are generally more flexible than those for a standard Corporate Insolvency Resolution Process (CIRP). This flexibility acknowledges the complexities of stabilizing a financial institution, allowing for extensions to the moratorium and resolution periods to preserve critical services and protect stakeholder interests.

Moratorium and Continuity of Critical Functions

A primary objective of the FSP Rules is to maintain the uninterrupted financial services vital to the economy. Upon admission of an insolvency application, a moratorium is imposed that prevents creditors from initiating recovery actions. However, it allows the FSP to continue its essential operations under the regulator’s supervision, thereby protecting depositors, policyholders, and overall market confidence.

Role of Regulators

Sectoral regulators, such as the RBI, play an active role by:

• Initiating the insolvency process.
• Monitoring the FSP’s management and operational continuity.
• Approving significant decisions made by the administrator.
• Overseeing asset quality and risk mitigation measures.

Their participation ensures that the resolution process adheres to prudential norms and systemic safeguards.

Resolution Mechanism and Options

The resolution framework for FSPs provides for tailored mechanisms, including:

• Amalgamation, reconstruction, or rehabilitation schemes.
• Transfer of assets and liabilities to a healthy entity or a “bridge institution”.
• Sale or restructuring of non-viable business segments.
• Liquidation as a last resort, with special provisions under the FSP Rules.
• These options are designed to preserve value, enhance recoveries, and minimize systemic disruption.

Challenges in the Insolvency Resolution of FSPs

• Complexity of Financial Products: Valuing and transferring complex financial assets and derivatives requires specialized expertise.

• Regulatory Overlaps: Seamless coordination between the NCLT and financial regulators is essential to avoid conflicts or delays.

• Public Interest Considerations: Balancing the interests of creditors with the protection of depositors and ensuring market stability complicates decision-making.

• Limited Legal Precedents: As the jurisprudence on FSP insolvency is still nascent in India, its evolution could create uncertainty.

• Capacity and Coordination Among Stakeholders: The involvement of multiple regulators, creditors, auditors, and legal entities demands robust institutional frameworks.

Proposed Reforms and Future Developments

Recent discussions and proposed reforms, as might be reflected in a hypothetical future amendment bill, aim to further strengthen the insolvency framework for FSPs. Key areas of focus include:

Expansion of the FSP Regime

Proposals aim to broaden the definition of FSPs that can be brought under the IBC framework, allowing for enhanced regulatory oversight and tailored insolvency proceedings for a wider range of financial firms.

Enhanced Regulatory Powers

Future amendments are expected to strengthen the authority of the Insolvency and Bankruptcy Board of India (IBBI) and financial regulators like the RBI, allowing for greater supervision of insolvency proceedings to safeguard public interest and ensure the continuity of critical financial functions.

Streamlined Resolution Timelines

Acknowledging the systemic importance of FSPs, proposed reforms emphasize expediting the resolution process through stricter deadlines, while retaining the flexibility needed for regulators to provide input and maintain operational continuity.

Moratorium and Continuity Safeguards

There is a focus on extending moratorium protections into the liquidation phase for FSPs to prevent asset diversion. Furthermore, proposals aim to formalize provisions for the continuity of critical services like payment systems and policy operations under regulatory oversight during resolution.

Clarification on Priority of Claims

A significant area for reform is clarifying the “waterfall mechanism” under the IBC. Proposed changes aim to specify that statutory dues (e.g., tax claims) do not rank equally with secured creditors, which would protect creditor rights and ensure a clear and predictable priority of payments.

Institutional and Disciplinary Reforms

Proposals also include increasing the penalty cap for misconduct by insolvency professionals and establishing more disciplinary committees to ensure greater accountability, which is particularly important in the complex landscape of FSP insolvency.

Integration with Cross-Border and Group Insolvency Frameworks

Given the multinational exposure of many large financial institutions, future amendments are expected to introduce frameworks for cross-border and group insolvency, creating a more holistic and internationally compliant resolution environment.

AMLEGALS Remarks

Streamlining the insolvency resolution of FSPs is vital for safeguarding India’s financial stability and investor confidence. Through the specially designed FSP Rules of 2019 and ongoing reform efforts, the insolvency framework is evolving to address the unique challenges posed by financial institutions. The focus on continuity of critical functions, regulatory oversight, and flexible timelines effectively balances the needs of creditors with public interest concerns.

Going forward, effective implementation will demand robust cooperation between insolvency authorities, regulators, creditors, and other stakeholders. Building institutional capacity, adopting technological solutions, and continually refining legal frameworks will be critical to achieving a resilient, transparent, and efficient insolvency regime for financial services—a cornerstone for a stable and progressive financial ecosystem in India

— Team AMLEGALS

Please reach out to us at rohit.lalwani@amlegals.com in case of any query.