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Event update: Financials - SC striking down Feb 12 circular could further delay stress resolution

The Supreme Court has struck down the RBI’s Feb 12 circular on the grounds that the regulator does not have over arching powers to issue an umbrella directive to banks to refer cases under the bankruptcy code. The RBI has the power to direct banks to refer one or more specific corporate borrowers under the code when a default occurs and that too after a notification from the central government. The Feb 12 circular was a generic circular that applied to all sectors for accounts above Rs20bn and did not relate to specific corporates. Hence RBI acted beyond its powers while issuing this generic circular. Following today’s judgment all cases that were referred to IBC just because of the circular will be pulled out.

Impact – Negative for banks and credit culture: 1) We believe RBI’s circular would have lead to faster resolution of stress loans which has already been delayed for a long time. With the circular being struck down, stress asset resolution will be delayed which will lead to bigger haircuts and eventually higher provisioning. 2) It is negative for credit culture. 3) It also opens up the scope for borrowers that were referred to the NCLT in RBI’s lists I&II to sue the RBI based on this judgment. RBI had directed banks to refer 12 accounts under list I totaling to Rs2 trn and 30 accounts under list II totaling to Rs1.4trn under the IBC in 2017. While senior lawyers believe that the judgment will not have any negative impact on RBI’s first two lists because they were specific to a few borrowers, it does throw open a window for litigation 4) It does not in any way change the existing NPL recognition or stress loan reporting norms for banks 5) Feb 12 circular did not mandate any new provisioning norms, so there would be no scope for write-backs of existing provisions for banks.

Background: The Feb 12 circular introduced last year had dismantled all existing restructuring schemes and asked banks to find a resolution plan for any account above Rs20bn which was even a day overdue. Banks were given 180 days to implement the resolution plan from the day the account became one day overdue, failing which they had to refer the borrower under the IBC within 15 days. The rule applied to all accounts above Rs20bn across all sectors. Corporates from power and later from sugar, fertilizers and the infrastructure sector challenged this circular. The basis of the Feb 12 circular was Sec 35AA of the Banking Regulation Act. Today’s Supreme Court judgment has laid down that RBI had not correctly interpreted and applied that section. It had used the section to make an umbrella directive whereas the actual scope of Sec 35AA is that it allows RBI to direct banks only for specific accounts and that too after notification from the Central Government. Those who had approached the SC against the RBI circular included Independent Power Producers Association of India, Association of Power Producers, South Indian Sugar Mills Association–Tamil Nadu, Dharani Sugar & Chemicals, the Shipyards Association of India, Punj Lloyd, the All India Bank Officers’ Confederation, and other groups representing shipyards and textile companies.

Quantum of corporate loans that will get relief – Rs2 trillion. We believe the following corporate borrowers will get relief 1) The power loans under SBI’s Samadhan scheme where banks were working towards a resolution but had run out of time due to the 180 day deadline. Banks were trying to find resolutions for 7 power accounts under the Samadhan scheme but have been able to finalize only 3 accounts of Rs200bn so far. The total amount of the pending four power loans that still needs more time for resolution is Rs400bn 2) Power loans under the Samadhan scheme of Rs200bn where banks had already initiated bankruptcy proceedings 3) Power loans outside of Samadhan totaling to Rs900bn 4) Loans from other sectors of around Rs400-500bn. So the total amount of corporate debt that gets relief from this judgment is around Rs2trn.