Insights into Editorial: Serious setback: on SC setting aside RBI’s ‘Feb. 12 circular’

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Insights into Editorial: Serious setback: on SC setting aside RBI’s ‘Feb. 12 circular’        


               

Context:

The Supreme Court order quashing a circular issued by the RBI on resolution of bad loans is a setback to the evolving process for debt resolution.

According to data from the ratings agency ICRA, the voiding of the February 12, 2018 circular could slow down and complicate the resolution process for loans aggregating to as much as Rs.3.80 lakh crore across 70 large borrowers.

According to ICRA estimates, the total debt impacted by the circular at Rs 3.8 lakh crore, including Rs 2 lakh crore across 34 borrowers was in the power sector.

As of March 31, 2018, 92% of this debt had been classified as non-performing, and banks have made provisions (percentage of bad asset that has to be ‘provided for’) of over 25-40% on these accounts.

By taking a hard line and refusing to heed representations, the RBI may only have harmed its own well-intentioned move.

 

About Reserve Bank of India’s “February 12 circular”:

Through a notification issued on February 12, 2018, the RBI laid down a revised framework for the resolution of stressed assets, which replaced all its earlier instructions on the subject.

The circular introduced a new one-day default norm, as soon as there is a default in the borrower entity’s account with any lender, all lenders singly or jointly shall initiate steps to cure the default.

Banks were required to immediately start working on a resolution plan for accounts over Rs 2,000 crore, which was to be finalised within 180 days.

In the case of non-implementation, lenders were required to file an insolvency application.

This is basically to harmonise the framework for resolution of stressed assets.

 

RBI’s Intention to Introduce the Circular:

Mounting bad loans, which crossed 10% of all advances at that point, and the failure of existing schemes such as corporate debt restructuring, stressed asset resolution and the Scheme for Sustainable Structuring of Stressed Assets (S4A) to make a dent in resolving them formed the backdrop to this directive.

The circular was aimed at breaking the nexus between banks and defaulters, both of whom were content to evergreen loans under available schemes.

It introduced a certain credit discipline — banks had to recognise defaults immediately and attempt resolution within a six-month timeframe.

While borrowers risked being dragged into the insolvency process and losing control of their enterprises if they did not regularise their accounts.

RBI data prove the circular had begun to impact resolution positively.

 

Resolution of Stressed Assets Revised Framework:

Indian banks’ NPA as a percentage of advances is expected to be at 10.3 per cent as of March 2019, from 11.5 per cent in March 2018, according to RBI’s financial stability report.

The circular went into effect on the same day that it was issued, and all existing schemes for stressed asset resolution were withdrawn with immediate effect.

Banks were required to immediately start working on a resolution plan for accounts over Rs 2,000 crore, which was to be finalised within 180 days.

In case of non-implementation, lenders were required to file an insolvency application.

The circular had forced banks to recognise defaults by large borrowers with dues of over Rs.2,000 crore within a day after an instalment fell due; and if not resolved within six months after that, they had no choice but to refer these accounts for resolution under the Insolvency and Bankruptcy Code.

 

However, Supreme Court quashed February 12 Circular:

Supreme Court said that February 12 circular is “Ultra vires as a whole”, it means the RBI has gone beyond its powers and thus “of no effect in law”.

Supreme Court struck down the RBI circular giving lender Banks six months to resolve their stressed assets or move them under the Insolvency Code against the private entities, who have defaulted on loans worth over Rs. 2,000 Cr.

It gave relief to different sectors like power, telecom, sugar, fertilizer etc.

 

Impact of Supreme Court order of quashing Feb 12 circular:

  • The order provides immediate relief to companies that have defaulted in repayments, especially those in the power, shipping and sugar sectors.

 

  • However, many financial sector experts argued that the verdict could delay the process of stressed assets resolution, which had of late picked up pace.

 

  • Since banks will have the choice of devising resolution plans or going to the National Company Law Tribunal under the IBC, the urgency that the RBI’s rules had introduced in the system could be impacted.

 

  • Voiding of the February 12 circular is credit negative for Indian banks. The circular had significantly tightened stressed loan recognition and resolution for large borrowers.

 

  • The resolution of stressed loans impacted by the circular will be further delayed as the process may have to be started afresh.

 

  • The Indian Banks Association had sought a relaxation in the RBI’s norms for infrastructure and power companies.

 

  • Banks will continue to have the option of referring a defaulting borrower under the IBC, in case the resolution plan fails. However, the resolution process, which was expected to be expedited, may get delayed.

 

Conclusion:

The RBI’s good work done in debt resolution in the last one year should not be go in vain.

It is this credit discipline that risks being compromised now. The international ratings agency Moody’s has termed the development as “credit negative” for banks.

It is true that the circular failed to take into account the peculiarities of specific industries or borrowers and came up with a one-size-fits-all approach.

It is also true that not all borrowers were deliberate defaulters, and sectors such as power were laid low by externalities beyond the control of borrowers.

The RBI could have addressed these concerns when banks and borrowers from these sectors brought these issues to its notice.

It is now important for the central bank to ensure that the discipline in the system does not slacken.

The RBI should study the judgment closely, and quickly reframe its guidelines so that they are within the framework of the powers available to it under the law.