BQ: IBC Should Be Lenders’ Last Resort, Not Default Option

3 April 2019: The Supreme Court judgment on the Reserve Bank of India’s Feb. 12, 2018 circular on the resolution of stressed assets comes as a jolt to many. They see it as having the potential to disrupt an orderly process set in motion by the circular. They think that it will hamper banks in taking defaulters to the IBC. They fear that it will generally weaken the hands of bankers.

These apprehensions are misplaced. First, the circular has no bearing on any decisions taken by banks prior to the circular coming into force. Secondly, the judgment does not, in any way, prevent banks from taking defaulters to the Insolvency and Bankruptcy Code in ways prescribed in the Feb. 12 circular. They are still free to do so if they so decide in given cases. The crucial change now is that it is not mandatory for banks to follow the process laid down in the circular in all cases.

Where the judgment could potentially prove disruptive is with regard to cases that have gone to the IBC consequent to the Feb. 12 circular. These cases could now come under challenge. This is certainly a problem that banks have to wrestle with in the short-term. From a long-term point of view, however, the judgment could well turn out to be a positive for the banking system.

The judgment upholds the contention of the aggrieved petitioners—notably, power producers—that the RBI cannot order banks to follow a one-size-fits-all approach to resolution.

A default may occur despite the best intentions of the borrower and for reasons beyond the control of the borrower.

This is certainly true of power producers. They have suffered because the distribution companies do not pay on time, tariff revisions are unduly delayed, coal is not supplied as promised or power purchase agreements are not adhered to.

In such cases, stipulating a 180-day time frame for resolution, failing which the companies have to be liquidated creates a dire situation. It means that thousands of crores of valuable power assets will have to be sold as scrap given that there are not enough bidders for power sector assets. Both the government and Parliament’s Standing Committee on Finance have viewed this prospect with alarm. The Supreme Court judgment paves the way for exploring other options, something that both bankers and borrowers in the power sector have been keen on.

The problem with the Feb. 12 circular was not just the one-size-fits-all approach. Many bankers regard the 180-day time frame for resolution itself as highly unrealistic. They believe that a one-year time frame would be more appropriate. Where the time frame for resolution is unrealistic, going to the IBC becomes the default option in resolution. This is not a sound banking practice.

A bank-led resolution should be the first option and going to the IBC should be the last resort.

By giving more leeway for bank-led resolution, the Supreme Court judgment restores a certain balance to the resolution process.

That said, the onus is on the government to ensure that bank-led resolution is put on a firm footing. The fear psychosis at public sector banks is now so acute that management is reluctant to resolving cases on its own. It would prefer the IBC route if only because there is no fear of reprisal from the vigilance and other authorities. The Indian Banks Association has created a panel to oversee resolution plans for banks. It is not clear how far this has helped matters given the large number of cases that need resolution.

Many such panels will be required and they will have to staffed with bankers, chartered accountants, lawyers, and academics. The panels themselves will need a measure of protection. The way forward may well be to provide statutory backing to these panels. Parliament may need to consider passing an Act that provides for a ‘Loan Resolution Authority’ with the necessary powers and the necessary composition. The worst of all situations will be one where banks don’t arrive at resolution nor do they feel any compulsion to take cases to the IBC.

TT Ram Mohan is professor of finance and economics at IIM Ahmedabad.

The views expressed here are those of the author, and do not necessarily represent the views of BloombergQuint or its editorial team.

The Bloomberg Quint reported

Categories: General News, India Bankruptcy, Legal update

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