The biggest reason for RBI to challenge NCLAT's ILFS order is protection of Indian depositors’ interests. (Aniruddha Chowdhury/Mint)
The biggest reason for RBI to challenge NCLAT's ILFS order is protection of Indian depositors’ interests. (Aniruddha Chowdhury/Mint)

NCLAT order on IL&FS rewards imprudence, ignorance at banks

  • NCLAT's IL&FS order encourages banks to extend and pretend, an exercise that landed them in the current toxic loan soup in the first place
  • Now, if RBI does nothing, banks that proactively provided against IL&FS loans in the previous quarter will feel short-changed

As court orders go, the latest by National Company Law Appellate Tribunal (NCLAT) on Infrastructure Leasing and Financial Services Ltd (IL&FS) was bizarre. It ruled that all IL&FS loans should not be tagged as non-performing assets (NPAs) by banks, unless the court permits them to do so. This begs the question as to whether NCLAT has acted beyond its authority.

“First, it is unclear which provision empowers NCLAT to direct the manner in which banks should account for their assets. Second, when the order says all financial institutions, it is unclear whether they were even parties to the intervening application in which this order was passed," said Bhargavi Zaveri, senior researcher at think tank Indira Gandhi Institute of Development Research (IGIDR).

Pretending IL&FS NPAs don’t exist doesn’t negate the fact that banks aren’t earning anything out of them.
Pretending IL&FS NPAs don’t exist doesn’t negate the fact that banks aren’t earning anything out of them. (Naveen Kumar Saini/Mint)

Some experts have listed reasons as to why the Reserve Bank of India (RBI) should challenge this order. The hit to its credibility and authority is reason enough for the central bank to engage in a turf war. But that is not all.

The tribunal’s order rewards imprudence, encouraging banks to extend and pretend, an exercise that landed them in the current toxic loan soup in the first place. If RBI does nothing, banks that proactively provided against IL&FS loans in the previous quarter will feel short-changed.

The quandary for banks is they risk violating the income recognition and asset qualification norms of the regulator, if they abide by the court order. Whether RBI challenges the tribunal or not, it now has to direct banks on recognition and provisioning through a fresh communication.

The biggest reason for RBI to challenge is protection of Indian depositors’ interests. Pretending dud loans don’t exist doesn’t negate the fact that banks aren’t earning anything out of them. Since banks aren’t getting money out of borrowers, lenders are unable to give a higher return to depositors. “The depositors of these banks are ultimately the persons getting affected by this order. Why wasn’t RBI, as the protector of consumer interest, asked to convey its official stand on this to the tribunal?" asks Zaveri of IGIDR.

Another unsavoury outcome is the inequality the order creates among various financial creditors. By giving banks the chance to kick the can down the road, the tribunal has given them undue advantage versus others such as bondholders and mutual funds that have written down losses on their portfolios. Recall that IL&FS has already defaulted on several debt instruments.

For perspective, in October, NCLAT had stayed all proceedings against IL&FS, which meant that no company needed to pay any of its creditors. The tribunal later excluded 22 so-called “green" companies from this moratorium, when it was pointed out that they had the cash flows to pay. That left about 10 “amber" companies that were allowed to meet operational payment obligations and payments to senior secured financial creditors. Banks had made an argument that since they cannot access funds from the companies even though these firms have the ability to pay, asking them to provide against these loans is akin to a penalty.

The NCLAT order is in response to this feedback.

But as they say, the road to perdition is paved with good intentions. There is no substitute for prudence. Banks need to realize this and the tribunals need to refrain from distorting the field for stakeholders.

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