A new 'jugalbandi'

A rather unfortunate and antiquated quote about the relationship between a central bank and the government alludes to the role of the former being advising, but finally, complying. Perhaps it is more appropriate to think of the Reserve Bank of India as financial regulator and the Government as complementing each other. This is true of each of their respective domains and even more so in respect of their role in facilitating insolvency resolution. The RBI’s June 7 circular (“revised circular”) on the resolution of stressed assets restores this complementarity between these institutions. 

The Banking Regulation Amendment Act 2017 had empowered the central government to direct banks to trigger insolvency proceedings in respect of specific defaults, as well as empowered the RBI to issue directions in respect of stressed assets. This amendment and the subsequent February 12 resulted in several defaulting borrowers being taken to NCLT for insolvency proceedings. The SC judgment in April 2019 raised important issues. From a regulatory governance standpoint, as well as the signaling effect on the sometimes delicate government-RBI relationship, there were concerns.

The amendments which required the authorisation of the central government to issue instructions to banks to trigger proceedings against specific defaults had the impact of shifting the balance of regulatory power between the central government and the RBI. Theoretical literature on regulatory institutions posits the rationale for such institutions being two-fold: Credible commitment on the part of governments to take decisions on the basis of domain knowledge and depth and at an arms-length; as well as specialisation of expertise relation of increasingly complex regulatory functions. The Banking Regulation Act seemed to embody these principles by vesting in the RBI the authority to issue directions to banks in respect of loans and advances, as well as banking policy generally, without the requirement of the authorisation from any other source. 

The revised circular deploys tools squarely within the domain of the regulatory — prudential norms on provisioning which will have the same impact as the Amendment Act and the February 12 circular — encouraging references to IBC, but in a manner that respects the role of each institution. 

Further, the February 12 circular, by directing banks to trigger insolvency proceedings against borrowers whose resolution plan had failed was in effect micro-management by the RBI. The referee and coach instructing every move of market players. The revised circular reverts to the position of RBI nudging market players through a combination of incentives and disincentives in terms of provisioning benefits and forfeits; rather than a shove. Concerns have been raised by some quarters regarding whether the provisioning will constitute sufficient incentive for lenders. The revised circular requires additional provisioning (over and above capital already provided) which could act as a “stick” as well as the reversal of provisioning in the case of a successful resolution as well as filling, and then admission under IBC which could act as a “carrot”. On a lighter note, the revised circular is seen as achieving the same purpose as the original one. But with a dose of politeness.   
The revised circular did not prescribe separate frameworks for different sectors or industries. Among the bases for the challenge of the February 12 circular was that it adopts a one-size-fits-all approach rather than one that takes into account the specific issues of each sector — a “sector-agnostic” rather than “sector-friendly” approach. This was not the basis on which the circular was struck down and the RBI has done well not to adopt this approach in the revised circular. The balkanisation of insolvency framework for multiple sectors by the RBI could potentially lead to regulatory arbitrage; as well as bank lending skewing in the direction of certain troubled sectors. A sector specific insolvency resolution process, if at all, could be considered by the legislature at the appropriate stage, rather than through directions or circulars of the regulator. Further, the revised circular accords sufficient flexibility to lenders to arrive at a resolution plan that takes into account issues faced by specific sectors. It therefore uses the right balance of “rules” and “discretion” to address the concern of individual industries. 

The power under Section 35AA to issue directions with respect to specific defaults being referred for insolvency proceedings remains useful and may be employed at the appropriate occasion with the central government and the RBI coordinating in this regard. To prod banks to use the IBC, the approach of the revised circular is effective and certainly more polite. 

The government played its role brilliantly by enacting the IBC, as well as making amendments to the law and delegated legislation in response to ground realities. The RBI, through the revised circular is complementing the IBC by incentivising banks to use the provisions of the IBC. The circular displays a keen understanding of the nuances of the IBC and the manner in which banks could deploy them. By way of example, the circular complements super priority accorded to interim finance under the IBC by prescribing standard provisioning requirements for such finance as well as additional finance during the resolution period. This will provide an impetus for effective resolution, which is often held back by limitations of funding, despite super priority status under the IBC.

The June 7 circular also recognises the challenges of achieving unanimity by all lenders, and the need to act swiftly. The requirement for 100 per cent agreement has been brought down to 75 per cent in value and 60 per cent in number; with a safeguard introduced for dissenting lenders by ensuring them at least liquidation value. This is in line with the UNCITRAL Legislative Guide for Insolvency Law as well as the World Bank Ease of Business parameters on resolving insolvency. While the IBC and regulations thereunder have been amended to remove this requirement, its introduction in the Revised Circular is a useful incorporation of global best-practice. 

These developments therefore hopefully signal a welcome new “jugalbandi” between the government and the RBI as well as evolved regulatory governance. 

The author is managing partner, Cyril Amarchand Mangaldas

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