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Bankruptcy law in India: Supreme Court strikes down “bad asset” resolution

The Supreme Court of India

India is a difficult market for lenders. A change in insolvency law was therefore long overdue. Now, however, the Supreme Court has dunned a circular from the central bank that was supposed to remedy the situation.

The circular in question by the Supreme Court of India, was issued by the Reserve Bank of India (RBI) on 12 February 2018. It was intended to regulate banks’ dealings with debtors. The court declared the circular unconstitutional and “ultra vires”, meaning the central bank has acted beyond its powers by imposing the rule.

The official statement reads: “The impugned circular will have to be declared as ultra vires as a whole, and be declared to be of no effect in law. All actions taken under the said circular, including actions by which the Insolvency Code has been triggered must fall along with the said circular.”

In a first statement, the Governor of the RBI, Shaktikanta Das, said, the central bank will remain committed not only to maintain but also to speed up the resolution of stressed assets in the banking sector. “It is very critical for the stability of the banking sector and has an impact on the stability of the overall financial sector. We will do all that is possible to ensure the pace is maintained.”

Bankruptcy law in India changes approach on default

The circular required banks to be stricter with borrowers who delay repayments. It gave banks a 180-day-period to arrive at a debt-resolution plan (loan accounts of Rs 2,000 crore – 287mn USD – and more). If the banks fail to resolve the case within this period, they had to take the defaulters to bankruptcy court under Insolvency and Bankruptcy Code (IBC). 

The IBC was launched in 2016. Prior India lacked laws to force a default company to enter bankruptcy process. Former governor of RBI, Raghuram Rajan, described that Indian company promoters are often ‘ever-greening’ their debt. As Indian banks feared to increase their nonperforming assets on their books, banks would extend additional loans to their defaulting borrower. Thus they can make an overdue interest payment. The system itself gave company promoters a substantial power over lenders, Rajan said as reported by the Indian Express.

The new insolvency resolution regime and RBI’s regulation on nonperforming assets, on the other hand, have dramatically raised creditors’ recovery rates. According to the IBC Board, both the aggregate recovery rates of financial and operational creditors are currently stood at 48 per cent. As a comparison, India debt recovery rate in 2015 was around 20 per cent.

Between December 2016 and December 2018, there were 1,484 insolvency petitions admitted by the National Company Law Tribunal (NCLT) system. From that petitions, 302 cases ended up in liquidation and 79 reached resolution. On the latter case, most of the companies were sold to new owners.

A backward step of bankruptcy law in India

The Supreme Court’s ruling will now give the promoters of stressed assets an opportunity to renegotiate their debt with lenders  – without going through the insolvency process.

Banks and financial institution in India currently hold a total bad debt of over $146bn. Some bankers see a step backwards in the annulment of the bad debt circular.

New York-based brokerage Jefferies said in a report that India’s Supreme Court order is a big setback. The Indian central bank will not be able to direct “generic insolvency” proceedings. Similar comment comes from global rating agency Moody’s, which believes that the judgement was credit negative for Indian banks. Moody’s warns that the ruling could further delay the resolution process of bad debt in India.

Meanwhile, Japanese brokerage Nomura said the order provides the borrowers with some leeway to delay the resolution process, and Indian banks will have more flexibility in finding a resolution.

However, India Finance Minister Arun Jaitley states in an interview with the BusinessLine that the Supreme Court ruling will not impact IBC

Bankruptcy law in India shaking shadow-lending industry

The bankruptcy law in India has recently shaken up India’s shadow lender industry. In August 2018, a major infrastructure financing and construction company Infrastructure Leasing & Financial Services (IL&FS) missed some debt repayments from a total of $12.6bn debt. It is currently in the middle of the asset monetisation process.

The default case of IL&FS affected the shadow-lending industry in a broader term. Indian regulators cancelled the licences of 1,500 smaller non-banking finance companies (NBFCs) and put a higher standard for licences approval. The industry itself accounted for nearly 40 per cent of Indian consumer loans in the last three years.

A Citigroup analyst Manish B Shukla wrote in a report that about $22bn has evaporated from two dozens non-bank financial companies since the end of August and investors aren’t rushing to get back in.

“Despite the sharp correction in stock prices of NBFCs, most investors are cautious on these names given near-term uncertainties. The volatile third-quarter results and potential funding tightness after the recent events may be reasons for the lingering scepticism in the sector,” he concludes.