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The Supreme Court judgement setting aside a Reserve Bank of India (RBI) circular that hastened bankruptcy proceedings for big-loan defaulters has raised fresh questions about the process by which corporate failure is dealt with. On Tuesday, a two-judge bench, comprising Justices Rohinton Fali Nariman and Vineet Saran, ruled that the circular was beyond the central bank’s regulatory powers. Issued in February 2018, the circular directed lenders to categorize all loans larger than 2,000 crore whose repayment was delayed by even one day as stressed assets. This classification sets off a 180-day countdown during which lenders and the borrower have to agree on a plan to resolve the default, failing which the defaulting firm is taken over by creditors to be either hawked or liquidated under the Insolvency and Bankruptcy Code (IBC). The order had marked a tightening of the earlier rules, under which lenders got more time and space to rework terms before having to call their loans bad.

The RBI circular was contested by some defaulters on the ground that it’s not their fault they’re unable to repay their loans. Critics also said that banks ought to have the autonomy to take a relatively lenient view of defaults in cases with mitigating circumstances, instead of having every payback failure treated alike. Power generation companies in default, for instance, argued that their financial troubles were to be blamed on factors beyond their control. Many of them were owed large sums of money by state-run electricity suppliers, which have seen their own finances stretched by tariff cuts, bill waivers and other populist freebies given away by state governments. Some sugar companies are also victims of broader problems of solvency that can be traced directly to state policies. In its ruling, the apex court has held that Section 35AA of the Banking Regulation Act, 1949, does not allow RBI to issue a blanket directive relating to debtors. Orders under this section can only be on specific defaults by specific debtors. In the context of the companies that protested the central bank’s haste, the court observed that insolvency proceedings should be initiated on a case-by-case basis.

If the ruling applies with retrospective effect, it would come as a relief to companies that have passed their resolution deadline. Some firms in default could get back in talks with their lenders on reworking the terms of their loans. Others deeper in the process might demand they be given a chance to do likewise. On the whole, it would be a setback to the cause of a time-bound process for bankruptcy—the aim of the IBC reform—if an argument over when a loan is reported as “stressed" throws an otherwise clearly defined process into disarray. As it is, litigation has cast doubt on how smooth it has become since the Code came into effect. The government has been making proud claims of a new credit culture in India, with lenders no longer chasing borrowers to get their money back. Lenders have indeed been empowered by the IBC, but a controversy over the discretion they enjoy should not end up as a point of friction between the government and RBI. It would be best for both to harmonize the call for special cases to be given extra space with the need to fix India’s problem of bad debts. We need an efficient and fair regime based on clear rules that cannot be exploited by anybody.

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