The Supreme Court’s move to quash the Reserve Bank of India’s (RBI) February 12, 2018 circular on resolution of stressed assets provides the banking system with more flexibility and time in resolving stressed assets.
The RBI circular had mandated referring stressed assets to the National Company Law Tribunal (NCLT) if the banks were not able to implement a resolution plan within 180 days from the date it became overdue – a stringent timeline in the context of the processes that banks were hitherto used to.
While the RBI circular intended to speed up the resolution process, the apex court’s ruling now puts the onus back on banks for ensuring timely and effective resolution of stressed assets; the provisions of the Insolvency and Bankruptcy Code (IBC), though, continue to be available to them for such resolution.
The stressed power sector assets in the private sector will get the biggest respite from this as most of them were on the verge of being referred to NCLT. The additional flexibility on timelines does away with the imminent threat of significant haircuts on these exposures for lenders in the near term. Given the weak industry environment and limited bidder interest, the banks were staring at significant haircuts on many of these assets.
Says Krishnan Sitaraman, Senior Director, CRISIL Ratings, “Going forward, we should see banks having greater flexibility in deciding which stressed assets to be resolved using the IBC. The IBC is a very effective mechanism that has been upheld by courts in its entirety and the banks’ decisions to resolve stressed accounts through IBC could be led by whether such accounts involve wilful defaults or have become stressed due to adverse business conditions and environmental factors.”
On the other hand, the improvement in credit discipline in the past year and the expectation of quick turnaround in stressed assets resolution could come under some cloud. That’s because the RBI circular prioritised speedy resolution of stressed assets. Also, fear of losing control of their companies meant promoters worked actively with lenders to avoid referral to NCLT.
Nevertheless, the Supreme Court ruling is not expected to have any significant impact on new NPA accretion levels, as accelerated NPA recognition by banks has resulted in most of the stressed assets being recognised. However, the pace of reduction in the stock of NPAs could slowdown.
Says Rama Patel, Director, Financial Sector Ratings, “Incremental NPA formation is estimated to have halved to 3.7% (of opening net advances) for the full year ended March 31, 2019, compared with 7.4% in fiscal 2018. Further, prudent credit practices instituted by banks after the RBI circular should help avoid piling up of NPAs in the banking system over the near to medium term.”
While the near term impact of the apex court’s decision on the banking sector asset quality is limited, the RBI’s stance on the possible changes to regulations on resolution of stressed assets post the apex court’s decision will need to be seen. That could play a key role in determining the modalities of the resolution apparatus available to the banking system in the future as well as how credit culture pans out going forward, though a return to the pre-IBC era is not expected.