Blow to NPA recovery

Subir Roy
Senior Economic Analyst

The glimmer of hope that emerged for a better future for India’s debt-laden public sector banks with the introduction of the Insolvency and Bankruptcy Code seems to have been eclipsed, at least for the time being. This has prompted the International Monetary Fund (IMF) to observe that ‘further progress’ on NPAs is needed in India, and for emerging markets in general, addressing non-performing loans is of ‘first-order importance for financial stability’.

The setback has resulted from the Supreme Court striking down a key circular issued by banking regulator Reserve Bank of India (RBI) last year, laying down the procedure for bringing defaulting companies to book under the code. As is to be expected, there is little to find fault with the court’s reasoning or the rationality behind the scope of its order. 

A clutch of defaulting companies, mostly in the power sector, had taken the RBI to court, challenging the legal validity of the RBI circular. Significantly, the court has upheld the legality of the relevant sections of the Banking Regulation Act, but found that the circular, which was issued under the authority of those sections, exceeded its brief. 

To understate what is at stake, it is critical to assert that nothing less than the stability of India’s entire financial system will be threatened if its state-owned banks do not get rid of the albatross round their neck in the form of large NPAs created by defaulting companies controlled by influential business families. 

This lies at the heart of the malaise of crony capitalism which was enabled by the weak governance system in the banks that kept evergreening loans instead of asking the owners to pay up or lose ownership. The NDA government earned praise for bringing in the code as a sign that it meant business. 

But now, courtesy the court order, continuing work under the code, fraught at the best of times, seems threatened. To understand how the RBI got where it did, it is necessary to recall recent history. It is from 2015 that the RBI under the leadership of Raghuram Rajan decided to signal the banks that it meant business. It came up with a succession of processes to recognise and then seek resolution of NPAs like corporate debt restructuring, stressed asset resolution and S4A (sustainable structuring of stressed assets). But when none of these delivered, the RBI under the leadership of Urjit Patel came up with the February 2018 circular to banks.  

At its core, the circular left no discretion in the hands of the banks and did not go into whose fault it was that made a particular loan go bad in the first place — the government, as in the case of the power sector through its inability to get state-owned distribution companies to pay up, or promoters who were simply wilful defaulters. It stipulated that a loan had to be declared non-performing as soon as there was a failure to pay as per conditions, and if a resolution plan could not be finalised within 180 days, it had to be taken to the tribunal administering the code. 

The court found two infirmities with the circular. One, it painted all with the same brush, and two — this is the critical part — it issued a blanket procedure for bringing defaulting companies under the process of the code when the statute gave it the authority to order one company at a time as authorised by the government. 

So at the end of the day we have a legal framework under which the RBI will not decide which company will be taken by which bank to the tribunal under the code but the government will! That is, the same bureaucrat-politician nexus that was responsible for the rise of crony capitalism will decide on which industrialist the axe will fall!  

If there be a villain in the whole piece, it is the amendment to the Banking Regulation Act that brought in Sections 35AA and 35AB when the code was issued. This is when Section 35A of the original Act sufficiently empowered the RBI to take necessary action in directing banks to move against defaulting companies.  It is the two new sections which restricted the powers of the RBI and which, in the view of the court, caused the RBI to exceed its remit.   

We do not know why the government introduced the two sections or why the RBI did not make an issue of it then. When Patel eventually tried to act firm he had to leave. The point is that the amendments happened after Rajan’s departure; the government wanted to clip RBI’s wings. 

It is also worth asking if the court should have gone as far as it did. While declaring that the circular was not as per law, it could have said, for the sake of the stability of the financial system, and in order not to disrupt the process of loan resolution, it was holding the working of the judgment in abeyance and asking the RBI to come to it with a new circular in, say, two months, compliant with the law. When the court approved the new circular the orders issued under the old circular could be regularised. 

Then the RBI could take up with the government the idea of junking the two new sections. The present government is unlikely to give back to the RBI powers that it has recently taken away from it. But then, in two months’ time, a new government, of whatever complexion, will be in place with a fresh mandate from the people and the moral authority to act as it sees fit!