Last week, the outgoing President of India, Pranab Mukherjee, in his farewell speech at the parliament, made several observations on the value of ‘debate, discussion and dissent’ in a parliamentary democracy. While making observations on the parliament, he noted that the power of the government to make law via ordinances should be limited to being used only in compelling circumstances. According to the Indian constitution, the parliament has the power to enact laws. However, when the parliament is not in session, ordinances, as temporary laws may be issued by the president on the advice of the Union cabinet. This power is meant to allow the government to take legislative action in an emergent situation. However, such ordinances need to be approved by the parliament within six weeks of reassembling, else, they cease to operate. Within three years of the current Lok Sabha, 28 ordinances have been promulgated. In contrast, 25 ordinances were promulgated in the 15th Lok Sabha and 36 in the 14th Lok Sabha.
One such ordinance is the Banking Regulation (Amendment) Ordinance, 2017 that was promulgated in May 2017, after the budget session of the parliament. In keeping with the constitutional provisions, this week, the government introduced a Banking Regulation (Amendment) Bill to replace the Ordinance. The Bill amends the Banking Regulation Act, 1949 to allow the Reserve Bank of India (RBI) to issue directions to banks for initiating recovery proceedings against loan defaulters. These proceedings will be under the recently enacted Insolvency and Bankruptcy Code, 2016 (IBC). Over the past two months, the RBI has acted on these powers and directed banks to initiate recovery proceedings against 12 defaulters who are estimated to account for 25% of India’s non-performing assets (NPAs). The RBI has also identified another 488 defaulters for which banks have been directed to finalise a resolution plan within six months.
Options available to banks to recover non-performing assets
The NPAs are loans given by banks, where the borrower has stopped making interest or principal repayments for over 90 days. Over the years, NPAs, as a proportion of total loans extended by banks have increased from 2.3% in 2008 to 7.5% in 2016, which amounts to more than Rs 6 lakh crores. The current level of the NPAs indicate a stressed banking system where the lending capacity of banks is limited, thereby affecting investment and economic growth. In 2016, a parliamentary standing committee had observed that a majority of the stressed assets were in the five sectors of infrastructure, iron and steel, textiles, aviation and mining (including coal).
The recent growth in NPAs may be due to a range of factors. There may be factors outside the control of the business which make it difficult for the borrower to service his loan repayments, such as slowing down of the business cycle, drop in global commodity prices or delays in running projects due to land and environment clearances or other infrastructure issues. However, there also maybe cases where the borrower wilfully defaults on repayment despite having adequate resources to service outstanding loans. Typically, banks are in the best position to assess these factors to determine what course of action to take in order to recover an outstanding amount. For example, banks may choose to restructure the loan with the hope of improvement in the business cycle, or convert the debt to equity to hold majority shares in the company and therefore change the management of the company. In cases where the borrower’s outstanding loans are owed to more than one bank, all lenders may evolve a collective action plan for recovering the outstanding amount.
Other legal actions that banks can take include approaching the debt recovery tribunals for recovering of the outstanding amount from the defaulter, or taking possession of the collateral under the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002. More recently, in 2016, the IBC was enacted to provide a time bound process for creditors to recover the outstanding amount from a defaulter. In addition to all these options, under the current Bill, the RBI can also direct banks to initiate recovery proceedings in case there is a default.
Necessity of giving additional legislative powers to the RBI under the Banking Regulation (Amendment) Bill
Primarily, the Bill allows the central government to authorise the RBI to issue directions to banks to initiate recovery proceedings under the IBC in case of a default in loan repayment. This implies that the RBI can issue directions to banks for resolution of stressed assets (stressed assets include NPAs, and loans that have been restructured.) The government has justified these provisions as “urgent measures are required for their speedy resolution to improve the financial health of banking companies for proper economic growth of the country”.
The question therefore is – are the legal provisions in the Bill necessary for addressing the issue of rising NPAs?
It is interesting to note that RBI data indicates that loans given by public sector banks account for 88% of the NPAs in the country. As a majority shareholder in these banks, the government had the authority to initiate recovery of 88% of the NPAs under the IBC without involving the RBI or making legislative changes.
Moreover, the existing Section 35A of the 1949 Act allows the RBI to issue binding directions to banks in ‘public interest’ or where the functioning of a bank is detrimental to its interests, among others. The question is whether a high level of NPAs qualifies as ‘public interest’ or “detrimental to the interests of the banking company” and therefore allows the RBI to use powers under Section 35A to direct banks to initiate recovery proceedings under the Insolvency and Bankruptcy Code, 2016.
The fundamental question that the Bill raises is how role of the RBI as a banking regulator is envisaged. For example, is it appropriate for the RBI as a regulator, to direct banks on business decisions such as recovery of loans from specific defaulters. Ordinarily, a banking regulator is tasked with ensuring stability of the banking system and thereby preventing risks to the financial system. In doing so, the role of the regulator is restricted to formulating broad guidelines to be complied with by all banks. Giving of loans, assessing risk profile of borrowers, lending rates, and recovery in case of loan default are commercial decisions. Given they are in the business of assessing such factors, banks are in the best place to assess the likelihood of recovery, and not the banking regulator. It may be argued that economic exigencies and current proportion of the NPAs justify an emergency measure in the RBI having the power to direct banks on loan recovery. The legislature needs to determine is what will be the role of the RBI in the future. Will the power to direct banks on recovery of loans be available to RBI for an infinite period of time or shall is this power temporary in nature and shall cease after a particular time period?
In his speech to the parliament, the former president had recommended that if a matter is deemed urgent enough to warrant the issuing of an ordinance, the respective parliamentary standing committee should examine the matter and present its report within a time frame. In the current Lok Sabha, only 29% of Bills have been examined by standing committees. However, there have been instances when the Bills replacing ordinances related to allocation of coal, mining licenses and enemy property were referred to a select committee for examination. It remains to be seen whether the Banking Regulation Bill will go through the rigours of legislative scrutiny in the parliamentary standing committee or be passed without examination. The regulatory complexity and trade-offs that the Bill tries to address definitely requires detailed examination and deliberation by the parliament before it is enacted as law.
Mandira Kala is the head of research at PRS Legislative Research.