Once election results were declared and government formation was out of the way, the Reserve Bank of India (RBI) did not lose time in issuing a revised prudential framework for resolution of stressed assets. The revision became imperative after the Supreme Court ruled the original 12 February 2018 circular as ultra vires, or beyond the central bank’s legal powers. Two major changes characterize the revised framework. The first one is predictable: instead of mandating that banks begin a resolution process for stressed assets even after a day’s default and then mandatorily report the defaulter to the insolvency courts if the resolution process remained infructuous after 180 days, RBI now allows banks up to 30 days after the default to consider the future path of action, and affords them more latitude in taking defaulters to insolvency courts. However, failing to implement a resolution plan without going to the insolvency courts invokes penal provisions. The key change here is RBI’s carrot-and-stick approach. Lenders effectively get 30 days to negotiate with defaulters before putting in motion a 180-day resolution plan with other lenders. Interestingly, the process of kicking off a resolution plan has also been eased with assent required from only 75% of lenders by debt value, and 60% by number, unlike earlier where all lenders had to agree to the resolution plan. Yet, by not resolving a default in effectively 210 days and by not dragging defaulters to insolvency courts, banks will have to make higher and penal provisions. The second change is RBI expanding the coverage: the new circular now includes other lending agents like term-lending financial institutions (such as Exim Bank or Small Industries Development Bank of India), non-banking financial companies (NBFCs) and small finance banks, which somewhat evens out the misaligned regulatory plane.
The changes are both good and not so good. The good part is that the focus remains on timely resolution of sticky assets through mounting punitive provisions. Yet, this raises multiple issues given Indian banking industry’s unique characteristics. With close to 70% of assets in the state-owned banking system, where tenured bankers have little or nil incentive to pursue resolution, the likelihood of higher provisioning acting as a disincentive is suspect. Second, the expansion of coverage is expected to aid in the resolution of a larger universe of soured loans, especially those festering in NBFC portfolios. But two other important credit providers remain outside the regulatory ambit: mutual funds and private equity companies, which have become large credit dispensers (and, in some cases, active participants in the evergreening of non-performing assets) without necessarily investing in the requisite credit appraisal skills. Mutual funds, in particular, have been caught on the wrong foot after lending against the security of pledged shares and with exposures to dodgy NBFCs.
The onus then must shift to the government which has proclaimed the Insolvency and Bankruptcy Code (IBC) among its key achievements. Two policy initiatives are required. One, the government has to ensure that large corporates do not game the system, as some of the large corporate defaulters have successfully done so far by arbitraging the asymmetric legal framework. Two, unlike RBI, the government has the legislative remit to construct a concrete track to insolvency courts for defaulters. Setting up the IBC process and framework was indeed commendable; now it has to deliver on its mandate.