The Reserve Bank of India headquarters in Mumbai. Photo: AFP

With the Indian Supreme Court striking down the circular of the Reserve Bank of India (RBI) on resolving bad debts filed under the Insolvency and Bankruptcy Code (IBC), the resolution of defaulted accounts is expected to become a long-drawn-out process.

The court announced that it had annulled the Reserve Bank of India circular, issued on February 12, 2018, and said that, in issuing the directive, the banking regulator had acted beyond its legal powers. Analysts see the verdict as a blow, both to lenders and to the authority of the central bank.

The circular, released under the tenure of former RBI Governor Urjit Patel, had asked lenders to institute a board-approved policy for the resolution of stressed assets. Banks were told to start the resolution process as soon as a borrower defaulted on a term loan and were given 180 days to resolve the matter, failing which the account would have to be referred to the National Company Law Tribunal (NCLT).

Several companies, including some in the power and fertilizer sectors, challenged the circular on the grounds that it wrongly classified them as willful defaulters. They argued that their financial situations were affected by extraneous factors beyond their control, and therefore they could not be treated as willful defaulters.

The power companies, many of whom number among the country’s biggest debt defaulters, argued that they incurred bad debts because of arbitrary changes in government policy, failures on the part of the government to fulfill commitments, delayed regulatory responses, and non-payment of dues by distribution companies.

Major defaulting power companies include Adani Power, which has debts of nearly 530 billion rupees (US$7.73 billion) as of March 31, 2018; Reliance Power (317 billion rupees); and JP Power (234 billion rupees).

In the wake of the supreme court verdict, promoters can now negotiate debt resolution on a bilateral basis with lenders. The promoters will also be able to resolve defaulting accounts faster, as long as 66% of the consortium agrees to the settlement, compared with the 100% vote required under the scrapped RBI circular.

However, bankers feel that the supreme court verdict might prolong the resolution process, though they are still able to refer defaulting borrowers to the IBC if the resolution fails. Banks’ experiences of IBC cases so far has been mixed, with them being forced to accept losses of 50% or more in the settlement of defaulted accounts.

According to last year’s RBI circular, lenders had to classify a large loan account as stressed even if it missed repayment by a single day. Banks were also duty bound to refer all bad debt accounts of more than 20 billion rupees ($292 million) to the NCLT.

Lenders had to file an insolvency application under the IBC within 15 days of completion of a 180-day deadline. The circular also withdrew loan resolution mechanisms the RBI had implemented, such as corporate debt restructuring and strategic debt restructuring.

The IBC code came into effect in May 2016, under the present National Democratic Alliance government and while Raghuram Rajan was the RBI Governor. On February 15, 2016, Rajan provided a list of key defaulters to the government and sought action against them.

Later, on September 6, 2018, he submitted a 17-page note on India’s bad debt problem to the parliament’s estimates committee at the request of its chair, Murli Manohar Joshi. However, it is still not clear who are the defaulters and what action has been taken against them.

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