Protecting the insolvency process

Regulatory forbearance should be viewed with caution

In February, the Reserve Bank of India (RBI), which serves as the banking regulator and is thus overseeing the bank asset clean-up process, had announced stringent norms for banks to follow regarding the treatment of bad loans. In the current system, a single day’s delay in repayment will require the bank to recognise the borrower as having defaulted. This served an important purpose. For too long, banks had chosen to ignore bad loans, and had sought other methods, such as “restructuring” schemes, in order to avoid taking action or making proper provisions. Many banks have clearly misused the earlier rules for restructuring of loans; for example, only one of the 20 accounts for which banks invoked the SDR (strategic debt restructuring) schemes has been resolved. A zero-tolerance mechanism is considered necessary in order to force a clean-up. It is now being reported, however, that the finance ministry is urging the RBI to moderate these requirements. It has been suggested that the time limit for recognising default should be extended from a single day to 30 days. The finance ministry’s case is reportedly that the burden of repayment on small and medium enterprises is too heavy, and that companies will be forced to close, resulting in job losses.

The RBI should be careful about diluting its existing requirements. If a single day time limit is being seen as too stringent, the reason as to why these repayments are not coming in on time should be carefully investigated. The finance ministry’s argument regarding job losses is not entirely persuasive. The new bankruptcy process has been designed, and is constantly being tweaked, to ensure that there is the highest possible chance that assets remain operational, and thus that job losses are minimised. The insolvency and bankruptcy code is the fit and proper mechanism for the revival of stressed assets — but they have to be recognised as problematic. Any increase in the time limit for such recognition should only be announced by the RBI following a proper investigation as to the proportion of payments that are delayed by more than a single day for reasons unrelated to the solvency of the borrower. It should ignore any external pressure for additional regulatory forbearance. In any case, the bankruptcy procedure provides multiple avenues for existing owners or promoters to ensure that, if they have the money required to clear their debts, they keep their enterprises operational and stay in control. The RBI has kicked off a vitally important process, and for the sake of the larger economy, it should be allowed to continue unhampered.

One other suggestion from the finance ministry, however, is worth considering — regarding the weakening of the requirement that a resolution plan for a stressed asset be approved by all creditors. It has been proposed that the threshold for agreement be reduced to 75 per cent. This is a reasonable suggestion, which might speed up the resolution process and make it more efficient. The RBI should take the suggestion on board while moving forward. Overall, however, self-serving suggestions from banks, promoters, or the government seeking to delay or dilute the asset clean-up effort should be considered only with great care. The RBI must protect its regulatory independence.