SC order raises questions on the way Banking Regulation Act empowered RBI

The Supreme Court (SC) order quashing the circular of the Reserve Bank of India (RBI) issued on February 12, 2018, may have given relief to promoters of a large number of projects facing insolvency proceedings under the Insolvency and Bankruptcy Code (IBC).

But the apex court’s order, details of which are not yet available, will also raise many questions about the jurisdiction and effectiveness of the RBI as the banking regulator and, more importantly, about the validity of the amended provisions of the Banking Regulation Act. There will also be questions over the role of the RBI in future resolution of stressed loans and the manner in which it could intervene in the banks’ approach to tackling bad loans.

The RBI circular of February 12, 2018, had directed banks to follow a time-bound resolution process for their loans that go bad. Among other things, it allowed 180 days for the debt resolution of companies with loan accounts of over Rs 2,000 crore, failing which the banks would be required to take the loan-cases to the National Company Law Tribunal (NCLT) for insolvency resolution under the IBC.  

A large number of companies, with stressed loans in a range of sectors including shipping, sugar and power were to be dragged to the NCLT. Power companies, with projects worth over Rs 2 trillion, had moved courts  challenging the legality of the RBI circular. The Supreme Court ruling now has held the RBI circular ultra vires.  

Remember that the IBC was enacted in May 2016 and the Insolvency and Bankruptcy Board of India (IBBI) was set up in October that year to act as a regulator for facilitating insolvency resolution. In spite of this legislation and the setting up of the IBBI, the banks were a bit slow in taking their stressed loan accounts to the NCLT as provided under the IBC.

The scenario changed in May 2017, when the government promulgated an ordinance to amend the Banking Regulation Act. The ordinance became a law after being approved by Parliament in August 2017.

What did the change in the Banking Regulation Act achieve? It empowered the Union government to authorise the RBI to issue directions to banks for initiating proceedings in case of a default in loan repayment under the IBC. The amended law also allowed the RBI to issue directions to banks for resolution of stressed assets. And the RBI could specify authorities or committees to advise banks on resolution of stressed assets. The amended law provided that the members of such committees would be appointed or approved by the RBI.

Soon after the amendment to the Banking Regulation Act, the Union government had issued an authorisation letter to the RBI advising it to take necessary action against banks with regard to their loans that have become stressed under the provisions of the IBC.

Promptly, the RBI moved on many stressed loan accounts and banks too began referring those big cases to the NCLT. The February 12 circular from the RBI was part of that process. It put in place a new framework for resolution of stressed assets under the IBC. The wordings of the circular made it amply clear that the RBI was putting in place that revised framework under the IBC and on the strength of the amended Banking Regulation Act.

If the SC order now finds the RBI circular ultra vires, the question will be whether the problem arose in the manner in which the banking regulator was trying to enforce the circular or the manner in which the RBI was empowered by the amended Banking Regulation Act to initiate insolvency proceedings.

It is possible that the RBI would now have to give the banks greater leeway in deciding how each of them would like to deal with the individual stressed loan accounts. The central bank will see the SC order as having weakened its drive against stressed loans. Only a closer look at the detailed judgement of the apex court will help reveal the future direction of the insolvency resolution strategy of the RBI and how banks would deal with bad loans.