HT PAREKH FINANCE COLUMN
Bad Debt Resolution Hits
Judicial Roadblock
C P Chandrasekhar
With the Supreme Court having
declared ultra vires the Reserve
Bank of India circular directing
banks to pursue bad debt
resolution at any cost, the process
of making banks alone pay for
all-round errors has come to an
end. The Court has required the
government to specifically
authorise each resolution exercise
and not delegate blanket
authority to the RBI. This would
matter in cases such as in the
power sector where a misplaced
privatisation policy explains the
non-performing assets, which the
government would now have to
take into account. The Court’s
order also makes it difficult for
the RBI to pretend that it had no
role in the generation of the NPA s.
C P Chandrasekhar (cpchand@gmail.com) is
with the Centre for Economic Studies and
Planning, Jawaharlal Nehru University,
New Delhi.
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I
n a surprising and disruptive turn in
the Supreme Court, the Reserve Bank
of India’s (RBI) effort at penalising
corporate defaulters and cleaning the
books of India’s commercial banks has hit
another roadblock. In early April, the
Court struck down a circular issued by
the RBI on 12 February 2018, which
required banks to identify a loan account
as a Special Mention Account (SMA)
(Stage 1), even if the period of default on
payments is one day. In addition, if the
loan to a defaulting debtor is to the tune
of `2,000 crore or more, the banks were
required to agree on a resolution plan
within 180 days as of 1 March 2018, if the
default had already occurred or 180 days
from the date of default, if that were
later. A resolution plan required the
agreement of all creditors. If a resolution
plan cannot be agreed upon within that
time frame, the company has to be taken
to the bankruptcy court established under
the terms of the Insolvency and Bank-
ruptcy Code (IBC), 2016 within 15 days of
completion of the specified period.
According to the RBI, the circular was
based on the powers conferred on it by
Sections 35A of the Banking Regulation
Act as amended to include Sections 35AA
and 35AB, besides an order from the
finance ministry giving it blanket resolu-
tion powers. Despite the delays relative
to prescribed timelines that this resolu-
tion process has experienced in practice,
the process itself was seen as faster and
more effective (in terms of the propor-
tion of outstanding debt recovered) than
the Debt Recovery Tribunals (DRTs), the
Lok Adalats and the powers conferred
by the Securitisation and Reconstruc-
tion of Financial Assets and Enforce-
ment of Securities Interest (SARFAESI)
Act, 2002, which were the means of
recovery earlier. As a result, it was
expected that the new resolution process
APRIL 13, 2019
would help resolve the bad debt problem
with lower volumes of recapitalisation
support from a cash-strapped govern-
ment, and get credit moving once again.
These expectations were only partially
met, with the haircut required to be
taken by the banks in some cases prov-
ing to be substantial.
But, that was not the reason why the
process hit a roadblock. The Supreme Court
verdict was related to cases brought by
companies threatened with liquidation
because of default resulting from prob-
lems that, in their view, were not of their
own making. These companies felt that
they were being treated unfairly when
force-marched to liquidation. Moreover,
the banks too wanted flexibility in dealing
with the companies concerned because
the haircut they would have to take if
the companies were liquidated would
be substantial.
Such problems were particularly acute
in the power sector, where privatisation
of production and distribution, with reg-
ulation and tariff setting by official, but
ostensibly independent, regulators, was
proving to be difficult to sustain. Cost-
plus prices of power purchased by dis-
tributors are challenging the vulnerabil-
ity of the latter. Power producers are
finding it difficult to tie up power pur-
chase agreements (PPAs) at reasonable
prices, limiting their access to assured
coal supplies because of the policy link-
ing finalisation of PPAs to coal access.
The Supreme Court struck down coal
block allocations, worsening the coal
supply situation. Competition and the
desperation to sign PPAs are adversely
affecting the viability of power produc-
tion. In the event, private power projects
financed with lending from the banks
have either not got off the ground or not
turned in profits that allow them to meet
their interest and amortisation commit-
ments. If these firms were driven to liq-
uidation as the RBI insisted they should,
private investors whom the government
wants to incentivise as part of its
“reform” agenda would lose confidence,
banks would be forced to accept substan-
tial haircuts, and consumers of power
may face shortages.
vol lIV no 15 EPW Economic & Political Weekly

The defaults resulting from problems
faced by these and other similarly
placed producers in other sectors cannot
be equated to those of wilful defaulters
or those engaging in fraud. Moreover,
there seems to be a case for abjuring a
“one-size-fits-all” approach and adopt-
ing a different yardstick when dealing
with defaults in different sectors. That
the banks were willing to do so was
clear when they approached the RBI for
additional time (beyond the prescribed
maximum of 195 days between default
and filing for liquidation) to restructure
loans and resolve the bad debt problems
in the power sector. The RBI refused
to oblige.
What the RBI had done was to declare
non-performing assets (NPAs), resulting
very often from exogenous shocks or
even government policy as a problem
of the banks. And it decided under
Raghuram Rajan and then Urijit Patel to
adopt a tough approach towards both
recognising bad debt and resolving it.
Interestingly, the RBI’s ability to adopt
this approach was facilitated by the gov-
ernment which, initially by ordinance
and subsequently through legislative
amendment, inserted two new Sections
(35AA and 35AB) after Section 35A of the
Banking Regulation Act, 1949, which
enabled it
to authorise the Reserve Bank of India (RBI)
to direct banking companies to resolve spe-
cific stressed assets by initiating insolvency
resolution process, where required.
The resolution was to be as per the
guidelines included in the IBC, 2016. The
RBI was also delegated the power to
issue other directions for resolution, and
appoint or approve for appointment, author-
ities or committees to advise banking com-
panies for stressed asset resolution.1
The very next day after the ordinance
was promulgated the department of
financial services of the Ministry of
Finance issued an order (No SO 1435[E])
that states:
In exercise of the powers conferred by Sec-
tion 35AA of the Banking Regulation Act,
1949 (10 of 1949), the Central Government
hereby authorises the Reserve Bank of India
to issue such directions to any banking com-
pany or banking companies which may be
considered necessary to initiate insolvency
resolution process in respect of a default,
Economic & Political Weekly EPW APRIL 13, 2019
under the provisions of the Insolvency and
Bankruptcy Code, 2016.2
What the Supreme Court has done is
declare this blanket approach based on
central bank direction ultra vires, as it
takes too far the act of delegating pow-
ers of the government to the RBI. In view
of the Supreme Court judges hearing the
case (R F Nariman and Vineet Saran),
it is clear that the RBI can only direct bank-
ing institutions to move under the Insol-
vency Code if two conditions precedent are
specified, namely, (i) that there is a Central
Government authorisation to do so; and
(ii) that it should be in respect of specific
defaults.
In sum, the specifics of each case of
default needs to be considered by the
central government when authorising
the RBI to direct banking institutions to
start the resolution process and move for
liquidation, if necessary, under the
Insolvency Code.
One issue which arose is that while
the Court’s judgment related to the
interpretation of clauses in the Banking
Regulation Act, the circular issued by
the RBI applied to all creditors in any
Joint Lenders’ Forum (JLF), which would
include non-banking financial compa-
nies (NBFCs). But, on the grounds that it
would be “difficult to segregate the non-
banking financial institutions from
banks so as to make the circular appli-
cable to them even if it is ultra vires inso-
far as banks are concerned,” the judges
decided that “the impugned circular will
have to be declared as ultra vires as a
whole, and be declared to be of no effect
in law.”
The net effect is that any instance
where debtors have been proceeded
against as per the Insolvency Code only
because of the application of the 12 Feb-
ruary circular will be declared non est.
As a result, not only those whose pleas
were included in the case just decided,
but a host of others against whom the
insolvency proceedings were pending or
to be invoked, will now not be subject to
the inexorable, clockwork resolution
process prescribed by the RBI that is trig-
gered once default is registered even for
a day. The RBI would have to approach
the government in each case, and the
government, after due deliberation,
vol lIV no 15
HT PAREKH FINANCE COLUMN
would have to authorise initiation of the
resolution proceedings. In the process,
the government would have to consider
the pleas of the debtors and the views of
the lenders. The former would argue
that their circumstances are special and
not the result of mismanagement. The
latter would like to hold out for a better
deal if they fear that liquidation would
entail a huge and unacceptable haircut.
And the government too would consider
whether it would be burdening the pub-
lic sector banks (PSBs) with losses that
would necessitate recapitalisation with
funds from the exchequer which it can-
not release. A quick and sharp reduction
in NPAs is no more on the agenda.
This would inter alia (i) force the gov-
ernment to consider which factors give
rise to NPAs, such as its own policies that
affect both borrowing and lending
behaviour and the macroeconomic envi-
ronment with implications for corporate
performance; (ii) require the RBI to exer-
cise greater diligence when monitoring
and disciplining banks; and (iii) pressure
bank management to be cautious when
increasing exposure to large capital-
intensive projects. Such changes are
desirable, because measures like these
are more likely to rein in NPAs in the
medium term, rather than an unthink-
ing and hastily implemented resolution
process. The downside is, of course, that
wilful defaulters and fraudsters cannot
only get themselves a breather, but may
be able to manipulate outcomes under
the new regime in their favour.
Notes
1 Press note of the Ministry of Finance of 5 May
2017 issued by the Press Information Bureau
(Release ID:161588).
2 Quoted in Supreme Court judgment 42591_
2018_Judgement_02-April-2018.pdf www.sci.
gov.in.
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