The Reserve Bank of India. Photo: Reuters
The Reserve Bank of India. Photo: Reuters

The Centre’s approach to Insolvency and Bankruptcy Code has costs

The Banking Regulation (Amendment) Act, 2017 undercuts the credibility of institutions and the predictability of the law

One year ago, the Reserve Bank of India (RBI) issued a press release identifying 12 accounts, comprising about 25% of the gross non-performing assets (NPAs) of the banking system, as eligible for “immediate reference under IBC". It did so using the powers conferred on it by the Banking Regulation (Amendment) Ordinance, 2017. The ordinance empowered the Central government to authorize RBI to direct banks to trigger the Insolvency and Bankruptcy Code (IBC) in respect of a default. It also empowered the RBI to issue directions to banks for the resolution of stressed assets.

Although the ordinance was criticized on several counts, there was consensus on its value in signalling the political will to push banks to use the IBC. The discourse on the ordinance, therefore, focused on its timeliness and implications for the NPA crisis. However, scarce attention was given to the impact of the ordinance on the strength and credibility of institutions affected by it. A large body of work in economics links the quality of institutions to economic outcomes. Conventional knowledge would suggest that unless we pay attention to institutions, the most noble interventions will not achieve the desired economic outcomes—the classic example usually cited here being that of imposing capitalist institutions in post-Soviet Russia. Even as the jury is out on the utility of the ordinance, it and the ensuing regulatory interventions undermine the long-term credibility of institutions, including in particular the predictability of the IBC.

First, the ordinance’s constitutional propriety (as distinguished from constitutionality) is suspect. The NPA crisis did not emerge overnight. The Banking Regulation Act, 1949 confers wide powers on the RBI to issue directions to banks. Some of the major NPA accounts were already undergoing restructuring and the next Parliamentary session was eight weeks away. From this perspective, the urgency of using the ordinance route to confer specific direction-making powers on the RBI was unclear then and remains so now.

The legislative instrument may seem moot as Parliament subsequently passed the ordinance as a law without much debate. However, the issue assumes significance from the perspective of the credibility of the executive. India being the only parliamentary democracy to empower the executive to make laws through ordinances, there is ample jurisprudence from the courts reiterating that the President must invoke his ordinance-making power sparingly and only where he is satisfied that the circumstances require immediate action. With a year left for the general election, the 16th Lok Sabha has witnessed 37 ordinances, compared to 25 and 33 in the 15th and 14th Lok Sabhas respectively. Questions regarding the urgency of the circumstances warranting the ordinance, therefore, go to the root of institutional credibility in Indian democracy.

Second, the ordinance enhanced the powers of the Central government vis-a-vis the banking regulator. While the debate on the independence of the RBI in India has largely focused on its monetary policy function, its independence as a banking regulator is equally important as it entails regulating a sector dominated by government-owned entities. Perhaps more importantly, it reduces the credible commitment of the political executive to isolate regulatory functions by creating separate regulatory bodies.

All Indian laws contentiously confer general direction-making powers on the government when it comes to “policy" matters and regulators. The Reserve Bank of India Act, 1934, widens these powers by specifically allowing the Central government to issue directions, in public interest, to the RBI. Unlike other laws which link such powers to policy matters, the RBI Act makes no such qualifications. The ordinance perpetuates this philosophy by enhancing the authority of the government to issue directions to the RBI on what are purely commercial decisions of regulated entities.

Third, the ordinance expands the RBI’s regulatory jurisdiction with regard to intervening in banks’ commercial decision-making process. Given the amendment’s vague language, such intervention can range from determining the time-frame within which a bank must trigger insolvency to the kinds of decisions that the bank management may make during creditor committee meetings.

All Indian laws generally empower the regulator to issue directions to regulated entities in the “public interest". Be that as it may, conferring such powers on the RBI is akin to empowering the Securities and Exchange Board of India to direct a mutual fund to trigger the IBC on the default of the issuer of a bond in its debt portfolio.

A direct outcome of the ordinance is an RBI circular of 12 February. This circular essentially directed banks to resolve large defaulted accounts within 180 days from the date of default, and failing such resolution, to trigger insolvency. Triggering a resolution process is one of many options that a creditor may employ to deal with a stressed asset. A direction of this kind assumes that triggering the IBC within a given time-frame would be the best solution in any given case of a large default. Since liberalization, the overarching regulatory philosophy has been to reduce state intervention in commerce. The ordinance is a backward step in this arduous journey.

Finally, the ordinance adds to the unpredictability of the bankruptcy regime as a whole. For instance, the power of the RBI to direct banks to trigger the IBC is subject to authorization by the Centre. While the Centre has issued this authorization for the time being, there is little predictability about whether it will continue or be revoked or revised. Similarly, the extent of intervention by the RBI with respect to each defaulted account remains unclear.

Many would justify the ordinance and the ensuing regulatory measures as having been taken for the lack of better options for resolving the NPA crisis. But to ignore the impact of the ordinance on the credibility of institutions and the predictability of the law as a whole would be to play the ostrich.

The immediate benefits of the ordinance are not easily visible, and it has cost us predictability and institutional strength. The way forward now would be to bring in more certainty and stability in the administration of the IBC, even if doing so imposes short-term costs on individual participants or the system.

Bhargavi Zaveri is a researcher at the Finance Research Group, IGIDR

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