RBI’s Current Mechanism: To Build Resilient Financial System In India.

 

20 September, 2019

 

 

RBI’s revised norms- (Prudential Framework for Resolution of Stressed Assets) Directions, 2019 dated June 7, 2019

 

On April 2, 2019, Supreme Court (SC), in the matter of Dharani Sugars and Chemicals Ltd. Versus Union of India (Judgment) [1], has delivered a landmark judgement, which struck down the controversial Circular titled as “Resolution of Stressed Assets-Revised Framework” (Circular) issued by Reserve Bank of India (RBI) on February 12, 2018 [2]. In the wake of the judgement, the RBI has introduced a new guidelines, with a view to providing a framework for early recognition, reporting and time bound resolution of stressed assets. These guidelines made applicable with immediate effect that is June 7, 2019.

 

The Circular was aimed at early recognition and resolution of stressed assets and making the Insolvency and Bankruptcy Code, 2016 (IBC) pivotal in the entire framework.

 

JOURNEY OF THE CIRCULAR SINCE ITS INCEPTION:

 

The genesis of this issue dates back to May 5, 2017 when the Banking Regulation (Amendment) Ordinance, 2017 was notified and the Ordinance was passed with an intention to empower the Central Government (CG) to authorize the RBI to issue directions to banking companies to initiate insolvency resolution process (IRP) under the provisions of IBC.  Section 35AA and Section 35AB were introduced in the Banking Regulation Act, 1949. Section 35AA empowered the CG to authorize RBI for issuing directions to banks to initiate IRP proceedings while Section 35AB empowered the RBI to issue directions to the banking companies for resolution of stressed assets.

 

Subsequently on February 12, 2018, the Circular was came to be released by the RBI thereby introducing a framework aimed at resolution of stressed assets in the economy, including introduction of certain specific schemes at different points of time. The framework was notified by RBI, purportedly, deriving its powers from Sections 35A, 35AA and 35AB of the BR Act and section 45L of the Reserve Bank of India Act, 1934 (RBI Act).

 

According to the Circular, banks had to classify a loan account as stressed if there was even a day of default. The bankers had to mandatorily refer all accounts with over Rs 2,000 crore loans to the National Company Law Tribunal (NCLT) or the bankruptcy court if they failed to resolve the problem within 180 days of default. The banks had to file an insolvency application under the Insolvency and Bankruptcy Code 2016 within 15 days of the completion of the 180-day deadline.

The Circular repealed all the other frameworks for dealing with stressed assets namely, Framework for Revitalizing Distressed Assets, Corporate Debt Restructuring Scheme, Flexible Structuring of Existing Long Term Project Loans, Strategic Debt Restructuring Scheme (SDR), Change in Ownership outside SDR, Scheme for Sustainable Structuring of Stressed Assets (S4A), and Joint Lenders’ Forum (JLF), leaving IBC as the only mechanism for resolution. The Circular did not distinguish between genuine and wilful defaulters.

 

This entire framework raised eyebrows as the RBI had placed all defaulted accounts into one category without considering the special problems faced by each sector. Further, the framework being applicable even for a day of default was absolutely unreasonable.

 

Finally vide the judgment, the SC struck down the most controversial Circular on the grounds of illegality and procedural impropriety and all cases in which debtors have been proceeded against by financial creditors under Section 7 of the IBC, only because of the operation of the Impugned Circular were declared as proceedings which are faulted at the very inception and therefore were declared to be non-est. The most important issue which drew the attention of everyone was to the constitutional validity of Section 35AA and 35AB of the BR Act which was believed to be the source from which the RBI derived its power to issue this Circular. As per Section 35AA, RBI can only direct banking institutions to move under the IBC if two conditions are specified: That there is a CG authorization to do so; and that it should be in respect of specific defaults. The SC said that while issuing the impugned Circular, RBI needed CG authorization, which it did not obtain. Further, RBI could not have issued general omnibus order, as it is only authorized to issue orders on “specific defaults”. The SC held that Circular is ultra vires Section 35AA, and declared to be of no effect in law. Consequently, all actions taken under the Circular by which IBC has been triggered, have become null and void.

 

The key paragraph of the judgment wherein the SC has observed as follows:

 

“If a statute confers power to do a particular act and has laid down the method in which that power has to be exercised, it necessarily prohibits the doing of the act in any manner other than that which has been prescribed. Following this principle, therefore, it is clear that the RBI can only direct banking institutions to move under the Insolvency Code if two conditions precedent are specified, namely, (i) that there is a Central Government authorisation to do so; and (ii) that it should be in respect of specific defaults. The Section, therefore, by necessary implication, prohibits this power from being exercised in any manner other than the manner set out in Section 35AA.”

 

Hence, the journey of the Circular ended in view of this landmark judgment which brought a big relief to power, shipping, sugar and other companies.

 

THE DAWN OF NEW FRAMEWORK:

 

After the SC quashed RBI’s Circular which had mandated the lenders to start resolution even in case of one-day default, RBI as a curative measure, issued the revised framework, namely, the Reserve Bank of India (Prudential Framework for Resolution of Stressed Assets) Directions, 2019 (“Prudential Framework”) on June 7, 2019 for resolving stressed assets by offering lenders a 30-day period to label an aaccount as NPA [3]. The purpose of introducing the Prudential Framework has been laid down under Clause 4 which reads as follows: “These directions are issued with a view to providing a framework for early recognition, reporting and time bound resolution of stressed assets”. This framework is applicable to Scheduled commercial banks; All India term FIs; Small finance banks; and NBFC-ND-SI and NBFC-D.

 

The highlights of the framework are:

 

• The circular provides for a review period of 30 days. During this period, the borrower is required to study the borrower account carefully along with determining the procedure of implementation of the resolution plan;

 

• The RBI authorizes the lenders to implement the resolution plan in case of any instance of default. Therefore, the lender is required to implement the resolution plan even if there is no default that has taken place;

 

• The new framework has mandated the formation of an inter-creditor agreement (ICA) whereby the decision of lenders representing 75 percent of the credit facilities (fund based as well as non-fund based) and 60 percent of the lenders by number shall be binding upon all lenders. In addition to this, the ICA may provide for the rights and duties of the majority lenders, treatment of lenders on a priority basis in terms of cash flows and securities and the protection of the rights of the dissenting lenders;

 

• The reference date on the basis of aggregate exposures has been provided for. According to this, the reference date for the aggregate exposure of Rs. 20 billion and above is June 7, 2019, for an aggregate exposure of Rs. 15 billion and above but less than Rs.20 billion, the reference date shall be January 1, 2020 and for aggregate exposures of less than Rs. 15 billion, the reference date is yet to be announced;

 

• The revolving credit facilities are now treated differently for the purposes of being declared as NPA

 

• The RBI authorizes the lenders to formulate the board policies which is required to include the resolution plan that has to be implemented by the lender in case of any default;

 

This new framework provides for the penalties if the resolution is not achieved as per the intended timeline:

 

• For cases where resolution does not happen within 180 days post the review period, an additional provision of 20 percent will have to be made.

 

• If the resolution does not take place within 365 days from the commencement of the Review Period, a further additional provision of 15 percent (hence, total additional provision becomes 35 percent) will have to be made.

 

• These provisions will be over and above the ageing provisions that banks provide once the asset turns non-performing.

 

The increase in the number of NPAs has led to an adverse impact on the economy of our country. Though the Circular made the banks powerful in recovering their dues, the one-day default norm had created chaos in the corporate sector. The replacement of RBI February 12, 2018 Circular with the new guidelines released on June 7, 2019 have brought the relief for the companies which found themselves in a position of disadvantage when the February 12 Circular was invoked. To the certain extent, even the banks were not comfortable with the Circular as their books looked more vulnerable. The main bone of contention was the one-day default recognition and the forced resolution through IBC, in case a solution was not found in a time-bound manner. Now the revised norms have allowed the banks more time and flexibility to consider how they want to treat an account after it has defaulted. However, the new framework has received the mixed reactions from lenders. According to some, it is nothing but the comeback of the Circular February 12, 2018 as some of the features of the Circular are still the part of the new framework such as dispensation of schemes SDR, S4A, most importantly, lenders cannot escape provisioning. While according to others, the revised norms have given more freedom to lenders in implementing the asset resolution plan.