New Delhi: The Supreme Court said on Monday that banks can trade in debt until it decides on the validity of the practice, which the Gujarat high court has ruled as illegal.
The country’s apex court also allowed the Reserve Bank of India, or RBI, to become a party to the case.
The order, by a bench comprising judges S.H. Kapadia and A. Alam, followed petitions filed by ICICI Bank Ltd, Kotak Mahindra Bank Ltd and Standard Chartered Bank, challenging a 12 January order by the high court.
Debt trading involves the sale or transfer of debt, including non-performing loans. In?July?2005,?RBI had laid down guidelines that allowed banks, financial institutions and non-banking financial companies to purchase and sell non-performing assets where the entire credit risk associated with the asset would be transferred to the purchaser.
Because a loan is not a conventional financial instrument such as a share or a debenture, a debt is assigned by one party to another under a contract, or an assignment deed, based on terms and conditions mutually decided by parties to the transactions.
Bobby Parikh, who heads the banking and securities law practice at BMR Advisors, said the issue is “hugely important”. “Debt trading is an international practice undertaken by banking companies according to their risk-management profile and considerations of capital adequacies.”
Capital adequacy is a measure of a bank’s financial strength, expressed as a ratio of capital to risk-weighted assets. In India, commercial banks are required to maintain a capital adequacy ratio of at least 9%.
Parikh said if the Supreme Court ruled that debt trading was illegal, it would affect the current banking set-up where RBI guidelines allow such activity.
The Supreme Court bench protected the rights of the borrowers of the loans by directing the banks to undertake that they would reverse the debt-trading transaction if the court dismissed their case after hearing the matter.
The bench listed the case for hearing on 14 April and gave the parties three weeks to file documents before it. In addition to RBI, the Indian Banks’ Association, an industry lobby, was allowed to become a party to the case.
Furthermore, the court said that during the “pending hearing and disposal” of the petitions, “any disbursement” or payments made by the borrowers to secured creditors shall be made to assignee banks.
Earlier, when the petitions came up for hearing on 9 February, the apex court bench had directed that no steps should be taken to implement the high court ruling.