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India insolvency regime outlook

05 April 2019 Deepa Kumar

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

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