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On 2 April, the Supreme Court (SC) of India invalidated the
Reserve Bank of India's (RBI's) February 2018 regulation on the
Insolvency and Bankruptcy Code (IBC), arguing that the measure was
beyond the RBI's mandate. The RBI's regulation had required banks
to resolve stressed assets in large accounts within 180 days of
non-payment, or to consequently initiate insolvency proceedings.
The SC ruled in favor of approximately 50 petitions initiated by
companies in the power, shipping, and sugar sectors, which were
reportedly the most severely affected by the RBI regulation.
Significance
The SC ruling weakens the IBC regime, as the RBI regulation
created a rules-based system in which all banks were expected to
treat non-performing assets (NPAs) as impaired immediately after
non-payment across all sectors equally, and to resolve these in a
time-bound manner. With this framework now deemed unlawful, without
new RBI regulatory measures the resolution process will involve
individual banks applying independent timelines, thresholds, and
mechanisms for addressing NPAs and to resolve unpaid loans.
This increases banks' discretionary power and increases the risk
of inappropriate loan classification. The SC ruling clearly
increases the scope for government interference in IBC resolution.
The SC upheld Sections 35AA and 35AB of the Banking Regulation Act,
which allow the RBI to refer only one company at a time to
insolvency and for a specific default, with an additional
requirement for central government authorisation. This is likely to
reduce the number of NPAs that are referred to IBC - as indicated
by government's statements against the stringency of the February
2018 regulation during the past year - particularly affecting the
above-listed sectors.
A slowdown in IBC referrals is more likely if Prime Minister
Narendra Modi secures a second term following the April-May
parliamentary elections. In the post-election outlook, if a new
government denies the RBI authority to require insolvency
proceedings against a defaulting company in the power, sugar,
steel, or infrastructure sectors, this would confirm increased
government interference. Conversely, if the RBI and a new
government collaborated to draft a new and legally valid
debt-restructuring scheme, this would limit banks' discretionary
flexibility.
Posted 05 April 2019 by Deepa Kumar, Senior Analyst – Asia-Pacific Country Risk, IHS Markit