The central bank will have to issue a revised circular for banks on bad debt resolution after a February 2018 circular was invalidated by the Supreme Court this week.
The RBI (Reserve Bank of India) will have to issue a new circular on how banks deal with non-performing assets, after the Supreme Court struck down a February 2018 circular on bad loan resolution.
The RBI’s February 2018 circular forced banks to reclassify stressed accounts as non-performing more quickly and initiate insolvency proceedings against defaulters of loan accounts over INR 20 billion (USD 290 million) if they are unable to put in place a rescue plan within six months.
The circular was long criticised for not allowing enough time for companies to resolve their financial difficulties, particularly in poor market conditions. Up to 50 petitions – most notably from power, shipping and sugar companies – have reportedly been filed to date challenging the constitutional validity and the one-size-fits-all approach of the RBI order.
On Tuesday (2 April), the Supreme Court declared the 180-day deadline to refer bad loan accounts to bankruptcy courts as unconstitutional and ultra vires, or beyond RBI authority under the Banking Regulation Act. Pointing to the language of the Act, the Court said the RBI can direct banks to initiate insolvency proceedings against a company only if a government order authorises it to do so, and only in respect of a specific default.
While it did not object to the circular’s other features, the Court’s judgment means the entire circular no longer has legal effect. Moody’s Investors Services vice president Srikanth Vadlamani said the judgment is credit negative for Indian banks.
“The circular had significantly tightened stressed loan recognition and resolution for large borrowers. But, with the voiding, this may now have to be watered down,” he said. “The resolution of stressed loans impacted by the circular will be further delayed as the process may have to be started afresh”.
Some bankers and lawyers say the ruling could delay an already slow debt resolution process and that it may hurt banks’ earnings. “This will once again mean we are back to the old days when banks and companies used to delay debt resolution, with each one trying to buy time,” said one banker cited by Reuters.
Some of the other features in the February 2018 circular have proven useful to the banking system, such as a requirement for banks to report to RBI’s central database when a borrower fails to make payments by a due date. Bankers reportedly say this rule has been useful to alert other lenders to the stress of a borrower, preventing companies from playing one bank against another.
Early recognition of borrower stress also helps in resolving stressed loan accounts, and allows credit to be channelled towards good borrowers.
On Thursday (4 April), RBI governor Shaktikanta Das told reporters the central bank will “take necessary steps, including issuance of a revised circular as may be necessary for expeditious and effective resolution of stressed assets.”
He did not indicate a timeline for the new circular.
