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Why the New Banking Regulation Ordinance May Fall Short?

The new amendments to the Banking Regulation Act-1949, seems to have caught everyone’s attention. Two reasons for the same, the burgeoning problem of NPA (especially the PSBs) and the hope that the new rules brings in (hope that it gives RBI strength to come down heavily on the defaulters).

Is the hope misplaced? Both ‘Yes’ & ‘No’. But for that we need to analyze a little on what the amendments are and what promises it brings in.

The ordinance adds two new sections 35AA & 35AB to the already existing Section 35A (Power of the Reserve Bank of India to give directions). To get a clarity, we need to first go through the original Section 35A and especially the one marked bold. Basically, the Section 35A empowers the RBI to issue directions to banks which the banks must necessarily comply with.

Section 35A (From the Banking Regulation Act, Inserted by the Act 95 of 1956, w.e.f. 14-1-1957)

(1) Where the Reserve Bank is satisfied that-

(a) in the public interest]; or

(aa) in the interest of banking policy; or

(b) to prevent the affairs of any banking company being conducted in a manner detrimental to the interests of the depositors or in a manner prejudicial to the interests of the banking company; or

(c) to secure the proper management of any banking company generally, it is necessary to issue directions to banking companies generally or to any banking company in particular, it may, from time to time, issue such directions as it deems fit, and the banking companies or the banking company, as the case may be, shall be bound to comply with such directions.

(2) The Reserve Bank may, on representation made to it or on its own motion, modify or cancel any direction issued under sub-section (1), and in so modifying or cancelling any direction may impose such conditions as it thinks fit, subject to which the modification or cancellation shall have effect.’

Now let’s look at the ordinance amendments:

35AA Insertion:

The Central Government may by order authorize the Reserve Bank to issue directions to any banking company or banking companies to initiate insolvency resolution process in respect of a default, under the provisions of the Insolvency and Bankruptcy Code, 2016

Note. – For this section, “default” has the same meaning assigned to it in the clause (12) of section 3 of the Insolvency and Bankruptcy Code, 2016’

For clarification, here is how “default” is defined under the Insolvency and Bankruptcy Code 2016; Quoting clause 12, section 3 of the Insolvency and Bankruptcy Code 2016:

‘”default” means non-payment of debt when whole or any part or instalment of the amount of debt has become due and payable and is not repaid by the debtor or the corporate debtor, as the case may be;’

Key outcome of the Section 35AA is primarily two:

  1. Power to Central Government to order RBI (wrt Insolvency only!). Some purists may claim this as an encroachment on RBI’s autonomy but n a closer look at the full Banking & Regulation act, one may find a few more instances where GOI has been authorized to give directions to the RBI. Hence we can skip the discussions wrt the same. For e.g. under Section 35- Inspection, the act reads “The Reserve Bank shall, if it has been directed by the Central Government to cause an inspection to be made, and may, in any other case, report to the Central Government on any inspection…”
  2. The more important one is empowering RBI to direct the banks to initiate insolvency process against defaulters.

Does this empowerment, outlined by #2 above, matter?

Till now the most critical notification of RBI wrt stressed asset management has been the JLF (Joint Lenders’ Forum) and CAP (Corrective Action plan) guideline issued on Feb, 2014. The notification basically directs the consortium lead bank to be the JLF convener (for loans granted under Consortium Agreement) and convene a JLF as soon as any account stress breaches criterion around ‘days due’ and the aggregate exposure (in INR). The JLF is supposed to identify a corrective action plan (which the debtor must mandatorily adhere to and the JLF needs to track the same to ensure time adherence). The actions can be ‘Rectification’, ‘Restructuring’ and ‘Recovery’. These is also monitored by RBI in overall. Now as per the ‘Insolvency & Bankruptcy Code 2016’, the JLF can be classified as a ‘financial creditor’ or for that case the lead bank surely is, and they can initiate insolvency process against the defaulting entity. So, till date, the JLF or the lender could have initiated insolvency process against a defaulter, Section 35AA empowers the RBI to direct a JLF/ bank to do so as well.

The rising level of provisioning, write backs & Gross NPA’s of banks, only ascertains the fact that the above mechanism of JLF has been much less effective than envisioned. Obviously, the necessity of the new ordinance tells on the efficacy of the earlier RBI notification. Either the banks have failed miserably in their recovery process because of long drawn legal process or they have been primarily pushing everything under ‘Rectification’ and ‘restructuring’ which is some parlance is called ‘evergreening of loans’ and is a ‘disaster waiting to happen!’. Of these two possibilities, the new Section 35AA can only benefit the banking ecosystem on the 2nd point as it allows RBI to give that necessary nudge (read direct) the banks to file insolvency and accelerate recovery. It may also create a fear among corporates who till now would have found easier to deal with the banks! Hence we said both ‘Yes’ or ‘No’ as while it gives more power to RBI but overall effectiveness will depend on how the new Insolvency act performs.

Now let us focus on the 2nd amendment / addition:

35AB Insertion:

(1) Without prejudice to the provision of Section 35A, the Reserve Bank may, from time to time, issue directions to the banking companies for resolution of stressed assets.

(2) The Reserve Bank may specify one or more authorities or committees with such members as the Reserve Bank may appoint or approve for appointment to advise banking companies on resolution of stressed assets.’

The 2nd amendment does not add any more value as Section 35A, anyway, authorizes RBI to direct banks (pt# 1 above) while the 2nd point is more an advisory, in nature.

Post this, RBI has issued a new notification to its original JLF notification. The revised notification is issued under Section 35A and 35AB. Primarily RBI has reduced the necessary mandate required for concurrence in JLF for deciding on CAP. This dilution of minimum mandate requirement is expected to speed up the faster decision making but need not be addressing the primary reason(s) why the JLF has been less effective than envisaged!

Under new notification:

‘…the decisions agreed upon by a minimum of 60 percent of creditors by value and 50 percent of creditors by number in the JLF would be considered as the basis for deciding the CAP, and will be binding on all lenders,..”

While the original notification spoke off:

The decisions agreed upon by a minimum of 75% of creditors by value and 60% of creditors by number in the JLF would be considered as the basis for proceeding with the restructuring of the account, and will be binding on all lenders under the terms of the ICA.’

Hence while only time will tell how effective the new Insolvency process is, considering anything legal in India is generally considered long drawn, without that being proven, the new banking ordinance & the subsequent notification of RBI seems to be ‘too little too late’ at least for the already stressed accounts.

Somewhere we are getting a feeling that these are being desperate attempts under trying times. The GOI is worried as banks are wary of lending out more to corporates and hence credit offtake is reducing which also has a cascading effect on the economic growth the government has envisioned and which is politically a very hot potato. The very moment inflation starts going south, things will become murkier. The savings rate will then have to go up, banks will then be forced to increase the loan/ credit rates to ensure healthy NIM and that will hit credit offtake further!

A more holistic review of the banking practices (why PSB’s are more badly hit? Taking more actions at early stage of defaults, leveraging blockchain to identify & block ‘willful defaulters’; speeding up the recovery process etc) is probably now grossly overdue!

Source:

http://egazette.nic.in (Ordinance 2017: Banking Regulation Act Amendment)

http://www.mca.gov.in/MinistryV2/insolvency+and+bankruptcy+code.html (The Insolvency & Bankruptcy Code 2016)

https://rbi.org.in/Scripts/NotificationUser.aspx?Id=10957&Mode=0 (JLF Revised Notification)

https://www.rbi.org.in/Scripts/NotificationUser.aspx?Id=8754&Mode=0 (JLF Original Notification, 2014)

http://www.lakshmisri.com/News-and-Publications/Publications/Articles/Corporate/corporate-insolvency-procedure-a-comment (Comment on the Insolvency & Bankruptcy Code 2016)

Useful links: http://ibbi.gov.in (Insolvency & Bankruptcy Board of India)

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