Why Is The Government Working At Cross Purposes With The Reserve Bank Of India?

In a fair world, whatever is good for the goose should also be good for the gander. But, in real world, this is not always the case and is at times quite the opposite.

The Reserve Bank of India (RBI) had issued, on February 12, 2018, a circular to all banks for resolving all non-performing assets within six months, failing which they should be subjected to the resolution process as per the Insolvency and Bankruptcy Code (IBC).

The Union Government has been making continuous efforts to seek a dispensation for favourable treatment for the defaulting companies in the power sector. The government approached the Allahabad High Court asking for a stay order on the RBI circular. The Court declined to stay the circular. 

It is highly unfortunate and distressing, in many ways, to observe the approach adopted by the Central Government in this matter. This betrays a complete lack of understanding, on the part of the government, of sound market economics as well as a fair regulatory policy framework. Let’s see why.

Firstly, the government wants a preferential regulatory treatment for one of the sectors. While it has cited various reasons for the same, the fundamental flaw in its argument is that it is, in this process, actually discriminating against the other sectors. Why should companies in the steel sector not be provided the same relief as the ones in the power sector? The reason, apparently cited, is that the steel prices are on the up-move and hence the steel companies do not require a special support as of now. So, are we saying that the sectors which are more distressed need to be supported more than the others? In that case, we would not require the IBC process in most cases. The companies which are distressed would get exempted from the IBC process and those which are doing well would anyway not default and hence be out of the IBC purview. 

Secondly, a fundamental principle of regulatory policy making is that it has to be sector agnostic. The regulations may be exempted from applying to any one sector if there is a strong evidence to believe that the said sector does not operate within the same framework as the rest of the economy. Otherwise, ignoring a sector from the regulations would lead to an under-measurement of the risk posed by that sector to the banks. This, in turn, would lead to negative surprises in terms of systemic risks for the banking sector as well as the broader economy. 

Thirdly, the technical definition of default on an obligation by a borrower to a bank is agnostic of sector or borrower category. Irrespective of the reasons behind the default, the concerned borrower has not honoured its obligation. The borrower should be classified as a defaulter and the bank has the right to enforce the same instruments of recovery against all defaulting borrowers. A bank should not be prevented from recovering its dues through legally enforceable methods.  

Fourthly, it is true that the shareholders of a bank have the right to exempt a borrower or a sector from repaying any part of its dues or allowing more time for the same. The Boards and Managements of the banks, on behalf of the shareholders, have currently been engaging, as a part of the IBC process, in negotiations with the defaulting borrowers. It should however be noted that the objective of the banks involved in the insolvency resolution process has been to maximise their recoveries. On the other hand, the government is openly supporting a delay in the resolution of loans to the power sector companies, thereby directly causing losses to the banks.

Fifthly, the government is guilty of openly and grossly breaching even the basic laws of corporate governance. While the government is, admittedly, the majority shareholder in the public sector banks (PSBs), it is flagrantly acting against the interests of the minority shareholders. How would the government justify its actions which lead to delays in the recovery of dues owed to the banks? The PSBs are managed by their respective Boards and Management and any pre-emptive action by the government would amount to not allowing the former to adopt the most viable path for recoveries of dues. 

Sixthly, let us evaluate the issue on basic and pure logic. The government believes that the power sector companies are going through a phase of temporary distress and they have significant intrinsic value and need support for some time. If this is a valid hypothesis, the banks should definitely receive resolution proposals through the IBC process. Indeed, the IBC process does not prohibit the government to work along with any potential bidders to provide support to the power sector companies as a part of the resolution plan. The prevention of a regulatory and recovery process applicable to an entire sector is suboptimal as well as illogical. 

Lastly, but clearly not the least of the reasons, is that the action of the government is perceived as a negative and biased effort to influence the RBI. This has a huge significance in terms of long-term moral hazard in the areas of regulatory policies and supervision. This will lead to demands, in future, by various sections of borrowers for exemption on various grounds. It may be a case of penny wise pound foolish for the economic policymakers to pursue an approach of brazenly pressurising the regulator for a patently wrong objective.    

I would strongly suggest that the government allow the process laid down by the RBI to be implemented smoothly. It should, in turn, adopt a constructive approach by working along with potential bidders in terms of supportive policies and resources for the power sector companies.  This would help optimise the economic values of the power companies as well as the banks, and thereby be in the national interest as well.