The Supreme Court order quashing the Reserve Bank of India’s rules on bad loans comes as a major disappointment to the dogmatic effort to clean-up the stressed banking system.
Declaring the central bank’s order as ultra-vires, this is likely to significantly affect the implementation of the bankruptcy process and the Insolvency Bankruptcy Code (IBC) over time.
The SC order may also subsequently renew friction between the Centre and the RBI in terms of mutually agreeing on a timeline for recovering dues from large corporations and deciding an appropriate time period for framing and implementing debt-restructuring programmes.
Also read: Supreme Court’s Bad Debt Ruling Hurts RBI’s Independence on Financial Regulation
In its February 12, 2018 circular, the RBI asked lenders to institute a board-approved policy for resolution of stressed assets. At the same time, commercial banks were told to start the resolution process as soon as a borrower would default on a term loan, and then were given a period of 180 days to cure it. If the borrower still failed to pay the defaulted sum in this extended period, the matter would then dragged to bankruptcy proceedings at the National Company Law Tribunal (NCLT).
Under previous guidelines – before the February 12 circular – India’s banks had the freedom to initiate the resolution process any time after 60 days from default-day. With the SC’s order now, defaulters are likely to get more time now before being sent to the bankruptcy court (or say, NCLT).
At this point, there are two immediate challenges for the RBI. The first is to see whether it would like to use or revive any of its old debt-restructuring schemes such as S4A, and refinancing scheme under 5:25. And secondly, it will now have to come up with a new framework on dealing with stressed assets (or bad loans).
The latter challenge is likely to take some time, meaning one may expect it to rely more or less on conventional monetary policy instruments to regulate and strengthen credit dissemination processes.
Meantime, India’s fledgling bankruptcy process may still lack the mettle to alter toxic lender-borrower behaviour – which is at the crux of whole issue.
All over the world, banks function on the two most essential currencies of confidence and trust. When there is a fragile trust-relationship with a borrower, commercial banks, over a period of time, remain reluctant to lend higher sums to firms, particularly in areas where credit demand is higher (say, infra, manufacturing) and credit-worthiness of big borrowers may be weak.
Also read: RBI to Issue Revised Circular on Resolution of Stressed Assets
This increases greater credit supply from areas of non-banking financial institutions (NBFCs) – a trend we have already seen in India.
Taking a step back, it is important to view the current SC order and NPA (non-performing asset) debate in the context of a far more structural concern. That is, India’s NPA culture, created by a fragile lender-borrower dynamic and a callously-delayed payment process system.
Getting rid of the NPA culture
Delayed payments are one of the most critical inception points of the credit process flow problems that exacerbate NPAs. Cash flow concerns often fuel the delays and this has been a part of the Indian banking culture for decades now.
Often these cash flow concerns are a result of delays in government programmes. Both union and state governments delay their own disbursements – especially when these are connected to those to the private sector. Nasscom for instance recently estimated how government dues to the IT industry could be more than Rs 5,000 crore.
Even though IT companies may prefer to invest domestically due to the sheer size of domestic IT infra-base and market potential to grow over the long run, private investment in big projects remains marred with institutionalised disincentives. These include disputed payments, litigation matters, poor enforcement of government contracts – to cite a few.
This problem is far worse in core sectors such as infrastructure and power.
While It is true that a decent chunk of NPAs come about as a result of fraud and malfeasance, an equally concerning problem is delayed cash flows. This seems contextually most relevant to the scenario of India’s power sector, which has the highest sectoral ratio of NPAs.
Most power projects still remain stalled or unproductive due to severe cash-flow concerns –related to buying of fuel, purchase agreements, tariffs needed to yield higher margins. In fact, in the Supreme Court-RBI tussle over the February 12 circular, more than 34 power generating companies with NPAs of Rs 1.4 lakh crore were involved in petitioning against the central bank’s circular.
Even though the SC has ruled in favour of these companies, offering a longer-time available to restructure their debt or finance dues through some kind of fire-sale, the core issues connected with their culture of delayed payments and cash-flow problems need sufficient and more pressing attention.
Also read: SC Order on Bad Loans Sets Stage for Future Battle Between RBI, Centre
At a time when unemployment levels are rising with aggregate private investment levels being dismally low across sectors, most firms within higher-growth capacity sectors (infrastructure, manufacturing, mining etc.), are likely to find it difficult to substantially raise credit. Building growth capacities across economy is critical for sustained job creation and requires a fluid and flexible credit culture, and building on confidence and trust to ensure due payments is key to ensuring this.
In terms of what’s needed, proposals on levying higher interests on delayed standard on-time payments –that are compounded over regular periods of time – may help.
For this, the government needs to proactively step up, remedying its own disbursement processes. The RBI, of course, would need to have operational and functional autonomy to regulate with real-time monitoring mechanisms and track delayed payments to address these issues sector-wise.
A better coordination mechanism between the RBI-government tribunals is needed and useful as a navigation device for stressed banks and (overdue) borrowers to work in-tandem and restore the credibility of the borrower-lender relationship.
Deepanshu Mohan is Associate Professor and Director, Centre for New Economics Studies at O.P. Jindal University. He is a Visiting Professor to Department of Economics, Carleton University, Canada.
