A blow to the IBC process?

A blow to the IBC process?

February 12, 2018, would go down as a milestone in banking as RBI brought out a circular wherein it came down hard on borrowers who were in default.

IBC Process

What is it all about?

  • The one-day rule kicked in, from whereon the two parties had to discuss to restructure, failing which the loan was referred to the IBC after 180 days, which then entered the resolution chain.
  • This has been struck down by the Supreme Court on April 2, after the case was referred to by some of the aggrieved companies, especially in the power, sugar and infrastructure sectors.

What does this mean?

  • It does seem that what was objectionable was that the circular looked at all companies in a similar manner. If a company was having problems because of external conditions, then it could not be bracketed with a wilful defaulter.
  • Hence, if every such default was referred to the IBC, the asset could finally get sold and the promoter could lose the company, which was not fair when there was a genuine problem.
  • The power sector had a grievance that if a generating company could not pay the loan, it was due to problems like the non-availability of coal, absence of PPAs being signed, default on the part of state-run discoms and so on. Therefore, special treatment was required here.
  • The circular said ‘no’ and treated all defaulters the same. The implicit logic was that if an exception was made to the power sector, it could be extended to telecom and steel and so on, and hence one could not draw a line. After all, in the absence of a wilful default that is hard to prove, business failure can always be linked with the environment. This made it contentious.

The consequences –

The fallout of the circular was that as banks started the talks with the customer on day 1, companies were performing better on an incremental basis as the fear of being referred to the IBC made them service their debt on time. But things now get reversed.

What would happen now?

  • First, from what it appears, RBI would have to go back to the circular and work out a fresh resolution mechanism. The February 12 circular had made this generic while it should have been specific according to the interpretation made in the legal fraternity.
  • Second, banks still have the prerogative to take the company to the IBC if a resolution with the borrower is not possible. So, the onus will be on the bank to decide if harsh action can be taken. But for sure when it is not binding, this situation can lead to more litigation where defaulters can appeal to courts when they are pushed to the IBC, and this delays the process.
  • Third, banks will have an incentive to be liberal with NPAs now and drag things along as they were doing earlier when the IBC did not exist. This will help reduce their NPAs and hence provisioning requirements. In a negative manner, the pressure on the government to recapitalise PSBs will reduce as they will now be more profitable.
  • Fourth, companies will also have the incentive to dodge payments, knowing they cannot be penalised immediately. This was the case earlier and will happen again at the margin. It is hard to identify a wilful defaulter today as this is rarely evident.

Uncertain future –

  • An interesting complexity that has come up now is how one deals with the past cases? What happens to assets that went to the IBC due to the February 12 circular and were sold as part of the resolution process? What happens to the cases that are in the process of being resolved? Will they be pulled out of the IBC? What is the future of the IBC now, considering that structures were set up starting from the IBBI?
  • The assets already sold that were driven by the February 12 circular could go for appeals. Those that are in the pipeline may stream out of the system. There will hence be a new set of complexity in the system in such cases.
  • Also, now that it is the end of the year, how would banks define their NPAs? How would the divergence issue be treated now that this ruling has come in? All this will have to be answered when preparing the books of banks. For sure, there will be a lot of reconciliation to do.

Conclusion –

The after-effects of this judgment need close monitoring because a relapse into the past cannot be ruled out. Rudimentary game theory suggests that when both the parties have an incentive to dodge the system, it becomes an efficient solution. The question is, what does the regulator do now?

SourceFinancial Express

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