Poor prescription

The National Company Law Appellate Tribunal (NCLAT) has ruled that the debt of Infrastructure Leasing & Financial Services (IL&FS) and its group entities should not be declared non-performing assets by lenders without explicit approval from the appellate tribunal. On the face of it, the NCLAT ruling passed last week will provide relief to both IL&FS and the banks that are reeling from huge non-performing assets. The NCLAT ruling implies a status quo that will help the lenders to avoid classifying loans of around Rs 53,000 crore as NPAs, helping them to avoid provisioning, at least for the time being. But the NCLAT should have thought through the issue before passing such an order.

The order is questionable on several grounds and creates the conditions for a potential turf war between the NCLAT and the Reserve Bank of India over the recognition of NPAs in the banking system. The first issue is that the NCLAT has drifted into an area that is clearly under the jurisdiction of India’s central bank, which should have the last word on which loan should be treated as NPA and which should not. Judicial intervention of this nature is better avoided as the NCLAT ruling effectively undermines the RBI’s sustained efforts over the past three years to push for greater recognition and provisioning of bad loans in the Indian banking system. There is no doubt that if banks were to follow the NCLAT ruling, they would be violating the RBI’s asset classification regulations. The ruling also reverses the RBI’s push against increased regulatory forbearance. At a time when the RBI’s autonomy is being widely debated, this cannot be a good development for the central bank’s authority and independence. This also goes against the RBI’s efforts to ensure that the sanctity of the loan covenant is not lost through specific dispensation and forbearance. The RBI had sound logic when it said in the past that the regulatory effort was to ensure that default recognition and provisioning are delinked from the reasons behind default.

There is another reason why the RBI should feel compelled to intervene. The NCLAT ruling directly hurts the interests of the common bank depositors. That’s because mere avoidance of recognition of an NPA does not help because banks will still not be able to earn any interest on such IL&FS loans. That, in turn, implies an erosion of depositors’ interests, which the RBI cannot allow. The second problem is that the order discriminates between different types of financial creditors of the IL&FS. In other words, it favours banks by allowing them to defer provisioning for bad loans and avoid the negative impact on their balance sheet, while providing no relief to bondholders and mutual funds. Thirdly, even within banks, the order sends a bad signal. That’s because it punishes those banks which have already provided for bad loans to IL&FS. Indeed, this order essentially encourages banks to pretend that nothing happened. But the point to note is at best, it will be a temporary relief to some banks. It would be wrong to assume the IL&FS issue as a one-off case, as the NCLAT order could become a precedent. The RBI has been silent so far, but it would do well to clearly articulate its position on the issue.

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