7 PM | SC order on RBI’s controversial ‘February 12 circular’ | 4 April, 2019


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Context

The Supreme Court struck down Reserve Bank of India’s February 12 circular and ruled it as unconstitutional.

What is February 12 circular

  • The circular completely revamped the rules tackling non-productive assets (NPAs). The circular was issued under the power enshrined by Section 35AA of the Banking Regulation Act. The section says that the central government may, by order, authorise the RBI to issue directions to any banking company to initiate insolvency resolution process in respect of a default, under IBC.
  • Under the new framework, the apex bank discontinued programmes for banks to restructure their defaulted loans and made the Insolvency and Bankruptcy Code as the main tool to deal with defaulters. The circular was aimed at breaking the nexus between banks and defaulters, both of whom were content to evergreen loans under available schemes. Some tools to deals with the stressed asset are
    • corporate debt restructuring (CDR),
    • Framework for Revitalising Distressed Assets
    • Flexible Structuring of Existing Long-Term Project Loans,
    • sustainable structuring of stressed assets (S4A),
    • strategic debt restructuring (SDR),
    • Change in Ownership outside SDR
  • The framework made it mandatory for banks to identify signs of incipient stress in loan accounts and classify stressed assets as Special Mention Account (SMA), immediately on default.
  • Even a single day’s default in debt servicing would require reporting to the RBI and implementation of Resolution Plan.
  • Under the revised framework, banks were given 180 days to resolve defaulting accounts of over Rs 2,000 crore.
  • If banks failed to implement a resolution plan within the timeline, they were required to take the company to National Company Law Tribunal (NCLT) for insolvency proceedings within 15 days of the end of the 180-day period.
  • Banks, too, would face penalties in case of failure to comply with the guidelines.

Issues with February 12 circular

  1. Less time to tackle bad loan: Several companies from the power and shipping sectors had challenged the circular, arguing that the time given by the RBI was not enough to tackle bad debt.
  2. One-size-fits-all approach: The circular failed to take into account the peculiarities of specific industries or borrowers. RBI failed to take into account of some sectors such as power sectors which were laid low by externalities beyond the control of borrowers.
  3. Violates article 14 – 180-day limit to all sectors of the economy without going into the special problems faced by each sector treat unequal equally, and, therefore, violative of Article 14 of the Constitution of India.
  4. Section 35AA of the Banking Regulation Act: This section granted specific power but RBI uses it in general approach. This section ruled as unconstitutional by the supreme court.

Time line of RBI’s February 12 Circular

  • February 12, 2018: RBI releases revised circular on Resolution of Stressed Assets
  • August 2018: Power Producers Association, Sugar and Shipping companies move High Court against circular.
  • August 2018: Allahabad High Court refuses to stay RBI February 12 circular; asks RBI and the government to hold consultations.
  • September 2018: The government uses never-before-used section 7 to hold consultations with RBI on February 12 circular among other issues.
  • September 2018: Supreme Court stays RBI February 12 circular for power, sugar and shipping companies until ruling in the matter.
  • April 2, 2019: Supreme Court ruled February 12 circular as unconstitutional

SC order on February 12 circular

The court was dealing with a bunch of petitions challenging the Constitutional validity of Sections 35AA and 35AB of the Banking Regulation Act, 1949. Sections 35AA and 35AB were introduced by an amendment to the Banking Regulation Act in May 2017.

  • Under Section 35AA, The Central Government may, by order, authorise the Reserve Bank to issue directions to any banking company or banking companies to initiate insolvency resolution process in respect of a default, under the provisions of the Insolvency and Bankruptcy Code, 2016.

The Supreme Court ruled that the Reserve Bank of India’s February 12, 2018 circular was ultra vires.  Apex court ruled that RBI could direct initiation of insolvency under the Insolvency and Bankruptcy Code, 2016 only with the authorisation of the Central government and also only in the “specific cases of resolution of non-performing assets” and not generally across the board.

Impact of SC order

  1. Relief to specific sectors: SC order may give relief to sectors such as power and shipyard. Defaulting borrowers in those cases may challenge banks
  2. Less provisioning requirement for banks: The decision opens up the possibility of less provisioning requirements as they could drop the tag of non-performing asset (NPA) in the case of some borrowers.
  3. Setback to debt resolution: This order may delay the timely resolution of stressed assets. The voiding of the February 12, 2018 circular could slow down and complicate the resolution process for loans aggregating to as much as ₹3.80 lakh crore across 70 large borrowers, according to data from the rating agency ICRA.
  4. Spinoff effect: The judgment is also a big setback for the central bank, which was planning to extend these norms to non-banking finance companies (NBFCs) as well.
  5. Impact credit disciple: It is important that we ensure discipline so that money borrowed from financial institutions is repaid. With this order, credit discipline is being compromised.

Way Ahead

The Supreme Court decision is the correction of a flaw and will provide flexibility to banks to restructure stressed assets without going through the formal bankruptcy resolution system. The issue needs to be relooked by both RBI and central government to arrive at a new regulation, which will ensure that the financial discipline from borrowers should continue.

Source: https://www.thehindu.com/opinion/editorial/serious-setback/article26726097.ece

 

 

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