The Reserve Bank of India is scrambling to deal with the crisis that erupted on Tuesday when the Supreme Court struck down a circular that it had issued on February 12 last year to speed up the resolution of mounting bad debts in the economy. The apex court declared that the circular, which had been challenged by power and cement companies, was ultra vires as the central bank had exceeded its authority by directing banks to initiate a 180-day resolution process against an entity for even one day of loan default. If the resolution process failed, banks had to haul the company to the bankruptcy courts under the terms of the Insolvency and Bankruptcy Code. The court was concerned that the central bank had issued a blanket directive which did not recognize the fact that defaults in certain sectors of the economy arose because of circumstances over which the promoters of these companies had no control. Besides, the central bank had issued the circular without consulting the Centre, which was a violation of Section 35AA of the Banking Regulation Act. The apex court said the RBI could only order banks to start such a time-bound resolution process in specific cases of default.

The RBI governor, Shaktikanta Das, has indicated that the central bank will rework the directive to comply with the Supreme Court order. The central bank continues to insist that it has powers — even if somewhat circumscribed — to order banks to initiate bankruptcy cases against large defaulters with outstanding dues of more than Rs 20 billion. But the upshot of the latest court order is that power producers, who are highly regulated and have been unable to recover their dues from state-owned electricity distribution companies, have been let off the hook. They owe more than Rs 2.2 trillion to the banks and there is no clear line of sight to the resolution of that massive debt.

The gross non-performing assets of all scheduled commercial banks swelled to Rs 10.4 trillion at the end of March 2018 with public sector banks accounting for more than 86 per cent of the amount. The RBI report on Trend and Progress of Banking in India 2017-18, which was released last December, reveals that the gross NPAs of the public sector banks amount to 14.6 per cent of their gross advances.

It is not hard to see why the central bank is pushing for resolution of the bad debts through the IBC process in preference to other mechanisms. Banks were able to recover 49.6 per cent of the Rs 99 billion dues involved in the 701 cases referred to the bankruptcy courts in 2017-18. That is twice the percentage of recovery from cases routed through the courts under the SARFAESI Act. Banks will be waiting to see the new RBI circular and hoping that the IBC process will take the burden of bad debt off their books. The downside is that banks could face the charge of cherry-picking defaulters.