Bankruptcy proceedings usually involve protecting a firm’s assets from creditors. An Indian tribunal has turned the concept on its head by offering protection to the lenders.

The National Company Law Appellate Tribunal (NCLAT) ordered that no lender can declare its exposure to embattled IL&FS Group as nonperforming without its permission — even if there is a default. The ruling by the bankruptcy court, which is overseeing the government-sponsored $12.8 billion insolvency of the infrastructure financier-operator, undermines the Reserve Bank of India’s powers to make banks and non-bank finance firms present a truthful account of their financial position at all times.

Already India has lost two RBI governors because, among other things, they dared to ask banks to acknowledge problem loans in time, classify them correctly and make adequate provisions for losses. Powerful business interests are holding on to their debt-funded empires with the help of complicit lenders who are loath to take such charges. Attempts to smash this cozy nexus has even involved penalizing bank CEOs for wrongly classifying bad loans as standard assets.

Those gains, painfully accumulated over the past three years, are being thrown away. Such expediency is silly. There’s nothing to stop the asset-classification relief being given in IL&FS from eventually becoming the norm in all bankruptcies. Already-delayed Indian tribunal proceedings will stretch forever, with no rush on creditors’ part to accept resolutions that involve haircuts. Extracting productive capital trapped in failed businesses will remain a challenge.

Shaktikanta Das, the former bureaucrat who now runs the RBI, has already started walking back from previous Governor Urjit Patel’s uncompromising position on bad-loan recognition. Defaulted loans to small enterprises have been allowed a one-time restructuring without being classified as nonperforming.

The bankruptcy tribunal’s intrusion into the central bank’s affairs takes that culture of regulatory forbearance a step further. It also comes at a dangerous time. Already the RBI’s autonomy – and capital – are under siege. A Chennai-based accountant who waged a campaign against Patel’s predecessor, Raghuram Rajan, for insisting on truth-telling and provisioning was rewarded by the government with a seat on the RBI’s board.

For Das, failing to mount a legal challenge to the ruling on loan classification could further damage the central bank’s credibility. Rather than being second-guessed at every step, the RBI may as well let the government, which owns 70% of the banking system’s assets, also be the regulator.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Andy Mukherjee is a Bloomberg Opinion columnist covering industrial companies and financial services. He previously was a columnist for Reuters Breakingviews. He has also worked for the Straits Times, ET NOW and Bloomberg News.

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