By making insolvency a generic and non-elective option for all bank defaulters, the RBI guidelines always ran the risk of being declared discriminatory and the Supreme Court judgment therefore comes as no surprise. But it is not just the legislative flaws that the judgement exposes, there are also some key takeaways from the verdict.

First, it exposes a long standing lacunae in the RBI’s regulatory oversight mechanism — the absence of relevant data on NPAs. At least since this data is not in the public domain, one can only surmise about its non-availability based on how the RBI approached the problem. Even if not formally available or disclosable, the presence of such a large number of infrastructure/core sector (power, roads, steel, shipping) industries in the list of NPAs should have signalled the need for a different approach.

Likewise, the spate of bank frauds witnessed in recent years clearly constitutes another obvious category, for which perhaps insolvency may have been the right solution. For the rest, an independent analysis of individual accounts would surely have revealed the true causes of default, which would also then point to the solution approach.

Instead, the RBI chose to lump all NPAs together by directing a common end game for all of them viz. the IBC.

Perhaps the magnitude and urgency led it to place its faith on the IBC being able to realise value from all of them. In hindsight, this could never have worked or gone uncontested. In fact even the government ordinance that empowered the RBI to act on loan defaults mandated a specific and not a general approach.

The second lesson relates to infrastructure finance — that the problem is not about the appropriateness of the redressal (insolvency versus restructuring) but about the inappropriateness of bank loans for financing infrastructure projects.

Infrastructure projects typically go through many years of implementation and long periods of operation before they can generate adequate cash flows and will therefore require long forbearance and deep pockets from financiers. Most importantly, they may not be able to always pass a 90-day default test.

Given the risks in infrastructure, commercial banks rarely finance them anywhere. But our public sector banks were forced to enter this space after the disappearance of specialised term lending institutions. The power sector in particular has symbolised everything that is wrong in our system.

Of the listed 34 stressed plants, only 60 per cent of capacity (24,000 MW) was completed, but over a third of this had no power purchase agreements (PPAs) or coal linkages, while another 16 per cent had disputed coal block allocations. As for the remaining, about 60 per cent had no PPAs and about 30 per cent had no coal linkages. Effectively, this meant that about 44 per cent of all capacity (including fully commissioned plants) had neither fuel supply nor selling arrangements in place, but banks had disbursed their loans in full — a sure fire prescription for non-performance from the word go!.

Power sector woes

At the heart of the problem was an overestimation of power demand and a reckless asset chase by banks. The government also played its part — its policy of favouring state-owned utilities by protecting them from the bidding process led to a pre-emption of PPAs in favour of utilities like NTPC, leaving private power producers stranded when it came to PPAs.

Finally, there seems to be a general misunderstanding about the purpose of asset quality norms because the impact seems more visible and pronounced for borrowers than banks. But these are actually targeted at reining in banks, specifically to prevent them from overstating the value of loans in their books (and thereby their net worth) and also to ensure they do not book non-existent income (from NPAs) and overstate their profits.

In a world predominantly driven by valuations and markets, there is greater reason today to ensure that accounting rules are not diluted. But because these are enshrined in regulatory rather than accounting principles, there is sometimes pressure on regulators to be lenient.

In fact the Parliamentary Standing Committee on power projects went so far as to suggest that the NPA guidelines were an “exercise in sophistry”.

We could do well to realise that we have travelled a long way from no norms (the situation until the Narasimham committee introduced them in the mid-nineties) to a liberal 120 days and finally the current 90-day default benchmark.

The writer is an independent consultant

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