The Supreme Court quashed circular issued by RBI - Seeker's Thoughts

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Saturday, 6 April 2019

The Supreme Court quashed circular issued by RBI


The Supreme Court order quashed a circular issued by the Reserve Bank of India(RBI) on resolution of bad loans is a setback to the evolving process for debt resolution.


The Overburdening of Loan

A Credit Suisse report estimated a total of 14.5 trillion stressed assets in the fourth quarter of 2016-17. Of this, infrastructure and construction contributed 20%; power utilities 17%; metals (mostly steel) 16%, and telecom 12%.


 Nearly half the amount had been lent to companies with an interest cover ratio of less than 1—that is, with earnings less than interest due—for eight successive quarters. Much of India’s corporate sector is in a debt trap. 

As of March 31, 2018, 92% of this debt had been classified as non-performing, and banks have made provisions over 25-40% on these accounts.
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Under the stringent RBI circular, banks had to recognise even one-day defaults and commence work for a resolution within 180 days to a stressed account.

If they failed to cobble up a plan in 180 days, they had to send the account (Rs 2,000 crore and above) to bankruptcy courts.

What is Reserve Bank of India’s “February 12 circular”?

Due to the rise in constant NPA, RBI issued a notification on 12th February 2018. The notification had a revised framework for the resolution of stressed assets or NPA. The notification or the circular introduced a new one-day default form.

This simply indicated that even a default for a day has to be tackled through the procedure.

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.

Why should the RBI’s Circular had to be implemented?

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. 

The response of rating agency

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.
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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.

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

 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:
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.

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.


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