UPSC MAINS 2019 : Supreme Court strikes down RBI’s Feb 2018 order on stressed assets


Topic : Supreme Court strikes down RBI’s Feb 2018 order on stressed assets

Topic in Syllabus: General Studies Paper 2: Indian Governance



The Supreme Court recently struck down Reserve Bank of India’s February 12 circular and ruled it as unconstitutional.


Why SC order on RBI’s controversial ‘February 12 circular’ matters

  • The central bank’s controversial ‘February 12 circular’ which tightened the framework for the resolution of stressed assets has been struck down by the Supreme Court.
  • The Supreme Court held the February 12 circular “ultra vires as a whole” essentially meaning the RBI had gone beyond its powers and thus “of no effect in law”.
  • Several companies from the power and shipping sectors had challenged the circular, arguing that the time given by the RBI was not enough to tackle bad debt.
  • Power producers, for instance, had argued that the RBI’s ‘one-size-fits-all’ approach was impractical since the sector was having to confront external factors that were beyond its control, and which made an early revival difficult for them.
  • These factors included the unavailability of coal and gas, and problems arising out of the failure of state governments to honour power purchase agreements.
  • Power companies had moved Allahabad High Court against the RBI circular, which had refused to grant them interim relief last August.
  • Shipping and sugar sector companies had approached other High Courts against the circular.
  • The Supreme Court clubbed together all these petitions. The RBI argued that the circular had been issued in the public interest, with a view to ensure the timely resolution of stressed assets.


What was the February 12 circular all about?

  • RBI made a One-Day Default Rule in which the banks had to treat a comapany as defaulter even if it misses repayment schedule by a day.
  • An Immediate Resolution Plan was put up by RBI, the lenders were told to put in place board-approved policies for resolution of stressed assests.
  • As far as the timeline is concerned, RBI circular mandates lenders to file insolvency applications if default persists for 180 days from and after March 1, 2018 for debts with aggregate exposure of more than Rs 2,000 crore.
  • RBI circular mentioned about scrapping of past resolution mechanisms. Framework for revitalizing distressed assests, corporate debt restructuring scheme, flexible strcting of existing long term project loans, strategic debt Restructing scheme (SDR), change in ownership outside SDR, and Scheme for substainable structuring of stressed assets (S4A) were withdrawn.


What was the SC Verdict?

  • RBI cannot make an all-season circular for every defaulter agnostic of sectors. The February 12 circular has no legal validity.
  • But under section 35AA, government has given power to RBI to direct banks to refer to NCLT only in specific cases-where there is a defalut- such as the first 12 large cases.


What did the “Resolution of Stressed Assets — Revised Framework” replace?

  • The circular went into effect on the same day that it was issued, and all existing schemes for stressed asset resolution were withdrawn with immediate effect.
  • These included the Framework for Revitalising Distressed Assets, Corporate Debt Restructuring Scheme, Flexible Structuring of Existing Long Term Project Loans, Strategic Debt Restructuring Scheme (SDR), Change in Ownership outside SDR, and Scheme for Sustainable Structuring of Stressed Assets (S4A).
  • All these schemes allowed more lenient terms of resolution than the February 12 circular, which specifically said that the resolution process must begin from day one of the default.
  • The circular was ostensibly intended to stop the “evergreening” of bad loans the practice of banks providing fresh loans to enable timely repayment by borrowers on existing loans.
  • The RBI warned banks that not adhering to the timelines laid down in the circular, or attempting to evergreen stressed accounts, would attract stringent supervisory and enforcement actions.
  • The government had earlier asked the RBI to make sector-specific relaxations in the timeline for the implementation of the circular.


Some previous tools to deals with the stressed asset are:

  • corporate debt restructuring (CDR),
  • Framework for Revitalising Distressed Assets
  • Flexible Structuring of Existing Long-Term Project Loans,
  • sustainable structuring of stressed assets (S4A),
  • strategic debt restructuring (SDR),
  • Change in Ownership outside SDR


What was the impact of 12th Feb circular on the performance of:

Due to the 12th Feb circular:

  • Banking sector reported a net loss of Rs55077 crore in FY18 vsRs 6575 crore
  • Banking sector reported GNPA of Rs10.27 lakh crorevs Rs8.87 lakh crore, up 15.7%
  • GNPA ratio of the sector increased to 12.13% vs 10.91%
  • PSU banks reported a net loss of Rs 62681 crorevsRs 18107 crore Private banks reported 17.5% rise in GNPA to Rs1.29 lakh crore
  • PSU banks reported 15.5% rise in GNPA to Rs8.98 lakh crore


Time line of RBI’s February 12 Circular:

  • February 12, 2018: RBI releases revised circular on Resolution of Stressed Assets
  • August 2018: Power Producers Association, Sugar and Shipping companies move High Court against circular.
  • August 2018: Allahabad High Court refuses to stay RBI February 12 circular; asks RBI and the government to hold consultations.
  • September 2018: The government uses never-before-used section 7 to hold consultations with RBI on February 12 circular among other issues.
  • September 2018: Supreme Court stays RBI February 12 circular for power, sugar and shipping companies until ruling in the matter.
  • April 2, 2019: Supreme Court ruled February 12 circular as unconstitutional


Impact of Supreme Court order:

  • The order provides immediate relief to companies that have defaulted in repayments, especially those in the power, shipping and sugar sectors.
  • However, many financial sector experts argued that the verdict could delay the process of stressed assets resolution, which had of late picked up pace.
  • Since banks will have the choice of devising resolution plans or going to the National Company Law Tribunal under the IBC, the urgency that the RBI’s rules had introduced in the system could be impacted.

  • “Voiding of the February 12 circular is credit negative for Indian banks.
  • The circular had significantly tightened stressed loan recognition and resolution for large borrowers.
  • The resolution of stressed loans impacted by the circular will be further delayed as the process may have to be started afresh,”
  • The Indian Banks Association had sought a relaxation in the RBI’s norms for infrastructure and power companies.
  • Bankers argued on that the quashing of the RBI circular was unlikely to impact ongoing cases at NCLT.
  • Since banks have already provisioned for likely loan losses, that process was unlikely to be reversed.


Why did RBI come with one-day default rule?

  • To compel lenders identify stress in loan account without delay for borrowers facing inability to repay.
  • To encourage prompt repayment of loans and to stop instances of deliberate delay in repayment by some borrowers despite their having the ability to pay by due date.
  • Moreover, The RBI wants the system to penalise the defaulter by way of rating downgrade, which would, in turn, increase the cost of fresh borrowing or raising capital.


What is Insolvency?

  • Simply speaking, insolvency is a financial state of being – one that is reached when you are unable to pay off your debts on time.
  • Insolvency is essentially the state of being that prompts one to file for bankruptcy. An entity – a person, family, or company – becomes insolvent when it cannot pay its lenders back on time.
  • Typically, those who become insolvent will take certain steps toward a resolution. One of the most common solutions for insolvency is bankruptcy.


What is Bankruptcy?

  • Bankruptcy, on the other hand, is a legal process that serves the purpose of resolving the issue of insolvency.
  • Bankruptcy is a legal declaration of one’s inability to pay off debts. When one files for bankruptcy, one obliges to pay off what is owed with help from the government.
  • In general, there are two main forms of bankruptcy –
  • Reorganization: Under reorganization bankruptcy, debtors restructure their repayment plans to make them more easily met.
  • Liquidation bankruptcy: Under liquidation bankruptcy, debtors sell certain assets in order to make money they can use to pay off their creditors.
  • It should be noted here that while insolvency is a financial situation and bankruptcy is a legal condition. Insolvency may or may not lead to bankruptcy.


The Insolvency and Bankruptcy Code, 2016:

  • It is considered as the biggest economic reform next only to GST. It offers a market determined, time bound mechanism for orderly resolution of insolvency, wherever possible, and orderly exit, wherever required.
  • The Code envisages an ecosystem comprising National Company Law Appellate Tribunal (NCLAT), National Company Law Tribunal (NCLT), and Debt Recovery Appellate Tribunal (DRAT), Debt Recovery Tribunal (DRT), Insolvency and Bankruptcy Board of India (Board), Information Utilities (IUs), Insolvency Professionals (IPs), Insolvency Professional Agencies (IPAs) and Insolvency Professional Entities (IPEs) for implementation of the Code.
  • The Insolvency and Bankruptcy Board of India was established on October 1, 2016 in accordance with the provisions of The Insolvency and Bankruptcy Code, 2016.
  • It provides a market-determined and time bound mechanism for orderly resolution of insolvency, wherever possible, and orderly exit, wherever required.


Sample Question:

What swayed the Supreme Court against RBI’s February 12 circular? Discuss