Story Of The Week

Setback for RBI: Mighty circular declared ultra vires

‘We have to be careful of not injecting more uncertainty than the economy can handle’

Raghuram Rajan

The Supreme Court of India recently set aside the Reserve Bank of India (RBI) circular on resolution of stressed assets, commonly known as February 12 circular, which laid down rules for acknowledging one-day defaults by large companies and in remedy called for insolvency action under the National Company Law Tribunal (NCLT), if the dues were more than Rs.2000 crore. While declaring February 12, 2018 circular of the central bank as void, Justice Rohinton F. Nariman mentioned that the court has declared the RBI circular ultra vires, which means beyond the scope of one’s legal authority. It was one of the 192 circulars issued by the RBI in 2018, however, it is considered as more powerful than any other circular ever issued by the central bank.

Intricacies of the circular

As per previous guidelines, lenders had the flexibility to initiate the resolution process after 60 days of such default by the private companies. Under its February 12, 2018 circular, the RBI had asked lenders to establish a policy, approved by the board for resolution of stressed assets. Also, banks were asked to initiate the resolution process as soon as a borrower backtrack on a term loan and were given 180 days to restore it, failing which the account would move under the insolvency code.

In case of a delay by the borrowers on a coupon or principal payment on a corporate bond even for a day, the market would penalize, but defaults in bank borrowings did not lead to a similar reaction. The revised framework by the central bank tried to reduce the arbitrage enjoyed by the borrowers while raising funds through borrowing from banks, as against the capital markets. The one-day default norms were clearly not received well by the industry and some lenders. Following this circular by the RBI, several petitioners including the stressed power firms went to different courts of the country. These entities included Essar Power Ltd, GMR Energy Ltd, KSR Energy Ltd, RattanIndia Power Ltd, Association of Power Producers (APP), Independent Power Producers Association of India among others. In their submission to the court, the power companies asked for the relief from both the circular as well as several regulation plans which were under implementation.

Source: Business Standard

In September last year, the Supreme Court granted temporary relief to the stressed power firms by directing the lenders to maintain the status quo. The apex court also directed that all pending cases filed against the RBI related to the circular should be transferred to it. Now as the Apex Court’s has decided to quash the circular, it will bring relief to several large companies, which were staring at insolvency proceedings.

Implications of the judgment

While defending the circular, the RBI had maintained the circular is in public interest, and it is in the interest of the national economy to see that enduring debt do not carry on indefinitely and come back into the economy. However, the mint street circular missed on two vital factors, Government authorization and the general nature of the circular, as circular was not concerning a specific default case. Here, the apex court accepted the argument presented by the petitioners that applying a standard 180 days limit to all sectors, without understanding sector-specific issues is like ‘one solution fits all’, which does not go well with them as they are governed by separate regulations.

Source: InsightsonIndia.com

The mighty circular got its powers from section 35AA of the Banking Regulation Act, which states that the government may, by order permit the reserve bank to issue directions to any banking company or banking companies to start insolvency resolution process in case of a default, as per the provisions of IBC code, 2016. The supreme court ruling clearly put that the RBI cannot come up with an order under section 35AA of the Banking Regulation Act without the government authorization.

What stands next?

The honorary court’s decision to quash the February 12 circular does not dilute the Insolvency and Bankruptcy Code (IBC) in any manner because banks can even now choose to drag defaulters under bankruptcy. However, with the apex court striking down the circular, resolution of default accounts filed in various tribunals under the Insolvency and Bankruptcy Code (IBC) will get delayed further. The supreme court order has raised doubts into everything the banks have done in pursuance of the circular, including any case filed for proceedings of insolvency. This comes as a shot in the arm for erring promoters as they will get a chance to resolve their accounts with the banks only. Here, the RBI needs to clearly lay down the guidelines under which debt resolution will be considered. Bankers already fear that this decision might delay the resolution process and lenders might need to start from the drawing board.

After the judgment, the RBI governor stated in its stand that the RBI is committed to maintain and enhance the resolution of stressed assets and it will take necessary steps to ensure adherence to credit discipline and issue of a revised circular, for effective and speedy resolution of the stressed assets. The government also observed that ruling is more procedural than systematic.

Source: Moneycontrol.com

RBI will be examining the implications of the Supreme Court judgment in detail and it may come up with a considered response or comments regarding a restructuring of loans, in some time. The Reserve Bank of India (RBI) will, for the time being, has left upon the individual banks to take decisions to deal with corporate loan defaulters, and the government has the option to exercise its majority shareholder rights to push public Sector banks to take insolvent companies to bankruptcy courts after taking stock of the Non-performing assets.

Clearly, as both the government and the mint street seem to be on the same page, we may assume that some defaulters who celebrated victory this week, after fighting the regulator for a year, may not be able to rejoice for long. The RBI should focus on studying the judgment closely, and quickly reframe its guidelines to save the good work done in the past one year in the debt resolution process.

 

References:

https://www.livemint.com/industry/banking/rbi-to-come-out-with-fresh-circular-on-resolution-of-bad-loans-shaktikanta-das-1554362652406.html

https://www.business-standard.com/article/companies/sc-quashes-rbi-insolvency-circular-relief-for-rs-2-trn-of-power-assets-119040200281_1.html

https://economictimes.indiatimes.com/industry/banking/finance/banking/how-rbis-feb-12-circular-changed-the-way-banks-dealt-with-stressed-assets/articleshow/67920150.cms

https://www.livemint.com/news/india/supreme-court-strikes-down-rbi-s-february-12-circular-on-bad-loan-resolution-1554182052362.html

Advertisements

Categories: Story Of The Week