Thus, the government opted for expediency instead of taking the hard step. Yes, disruption with respect to fiscal management was averted, but an easy option also meant that the government doled out the recapitalization bonds just to keep the banks running. Perhaps the risks of a disruption in the financial sector, which the closure of unviable banks would have surely caused, made the government more discreet and choosy about the banks that should get the capital. The total amount of capital available might have been less. But since this was capital provided at considerable cost, the government could have ensured that the banks that got recapitalization bonds performed as per expectations and the banks which did not get them wound down their businesses or even got merged with stronger entities. Avoiding a financial sector disruption had sown the seeds of a bigger disruption for the banking space perhaps after a few years. Conversely, embracing disruption at this stage could have paved the way for a stronger public-sector banking system, less vulnerable to the disruption and accumulation of more stressed assets.
Restructuring
The government stuck to its word on the question of restructuring of public-sector banks as one of the ways to rescue them from their financial stress. Jaitley had stated in his press conference, while announcing the bank recapitalization package, that the need for banking reforms was independent of the government’s objective of encouraging consolidation in the banking sector. The first big move on bank mergers was initiated on 1 April 2017. The Bharatiya Mahila Bank was merged with the SBI, India’s largest commercial bank. On the same day, five associate banks of the SBI were merged with it. The State Bank of Bikaner and Jaipur, the State Bank of Mysore, the State Bank of Travancore, the State Bank of Hyderabad and the State Bank of Patiala became part of the SBI, making it an even bigger behemoth. The process of mergers did not end here. On 17 September 2018, Jaitley announced the government’s plan to merge three public-sector banks—Bank of Baroda, Vijaya Bank and Dena Bank. While recapitalization bonds would help strengthen the balance sheet of as many as nineteen banks, the move to merge the three banks—one of them was a PCA bank—showed that the government was following up on its banking reform package. Even this move caused a major disruption in the public- sector banking space, like any merger does, raising serious questions on synergies and complementarities, but the government went ahead in the hope that the merged entity would be stronger and more capitalized to take on the challenges of staying healthy and meeting the investment needs of the economy through sustained lending. The merger of Vijaya Bank and Dena Bank with Bank of Baroda was completed on 1 April 2019. In a short span of just two years, the number of public-sector banks in India came down from twenty-six to nineteen. With no resistance or hurdles coming in the way, the government has now moved to implement yet another round of public-sector bank mergers. The proposed round could see the Union Bank and the Bank of India merge with the Punjab National Bank. When that happens, the number of public-sector banks would be seventeen—a reduction of more than a third of government-controlled banks in the country.
Resolution
The fourth R for addressing the twin balance sheet problem of the Indian economy was potentially the most disruptive of all the measures mooted by the government. This pertained to the resolution of stressed assets. Parliament passed the Insolvency and Bankruptcy Code in May 2016, which was a comprehensive insolvency legislation covering all companies, partnerships and individuals, excluding of course financial companies. The Code addressed the knotty problems of a multiplicity of different bankruptcy laws in a decisive way. It replaced all such laws like the Sick Industrial Companies Act, the Recovery of Debt Due to Banks and Financial Institutions Act, and the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act.
It provided a speedy process for early identification of financial stress and the resolution of entities if their underlying business was viable. Either a restructuring, if the entity was found to be viable, or liquidation was mandated under the Code within a timeframe—180 days after the process was initiated plus a ninety-day extension for resolving insolvency cases. A regulator—the Insolvency and Bankruptcy Board of India—was set up. The Code ensured that there was an adequate number of resolution professionals who could assist in the process of resolution or liquidation of an entity that had become insolvent under the law. Operational or financial creditors could approach the National Company Law Tribunals seeking redressal of their unsettled dues. Once an entity was admitted as insolvent, its management was entrusted with a committee of creditors, a body of professionals, who took charge of the company and ran it till a resolution was arrived at.
In a short span of time, the Insolvency and Bankruptcy Code made a considerable impact on insolvent companies and the problem of banks’ stressed loans, but not before the government stepped in with a crucial amendment in the Banking Regulation Act to expedite the NPA resolution. The law, amended in 2017, provided that the Central government could now authorize the RBI to issue directions to banks for initiating proceedings in loan repayment default cases under the provisions of the Insolvency and Bankruptcy Code, 2016. Accordingly, the RBI could periodically issue directions to banks for resolution of stressed loans and specify committees to advise banks on the resolution of stressed assets. The amended law was made applicable to the SBI and the regional rural banks. Thus, the government empowered itself to issue directions to the RBI for initiating the resolution of stressed assets under the Insolvency and Bankruptcy Code. The objective was that the government authorization would allow the RBI to move on such resolution quickly without any delay. Soon, the RBI did receive an authorization letter from the government under the amended law to move ahead with the resolution of stressed assets.
As at the end of 31 March 2019, a total of 1858 companies had been admitted under the Code. Of these, 152 cases, or 8 per cent, were closed on appeal or review. As many as ninety-one cases were withdrawn by those who applied before the courts under the Code. This was an indication of how the behaviour of borrowers changed as they were now becoming more compliant once the insolvency cases were taken up before the courts under the Code and they knew that they ran the risk of losing their company if they did not repay the dues. Ninety-four, or about 5 per cent, of the insolvency cases were successfully resolved and 378 companies, or about 20 per cent of the total cases, had to be liquidated. Importantly, almost three-fourths of the cases that had to be liquidated are about companies that were either defunct or languishing at the Board for Industrial and Financial Reconstruction, set up under the Sick Industrial Companies (Special Provisions) Act of 1985. This was also an indication of how the Code had worked much more effectively than the earlier law which had failed to bring about a quick resolution. The remaining 1143 cases were under different stages of the insolvency resolution process. A worrying aspect was that in spite of a stipulated timeframe of 270 days, as many as 362 of such cases or about 32 per cent had still not been settled in spite of their being admitted for more than 270 days. There were 186 cases (about 16 per cent) which were reported for the resolution process between 180 and 270 days and another 247 cases were reported between ninety and 180 days. And 348 cases were registered for less than ninety days. In other words, almost 48 per cent of the cases under different stages of the corporate insolvency resolution process had crossed the deadline of 180 days within which they were to be completed under the Code.
A big disruption the Code caused was in the area of promoters’ ownership of stressed companies. This was the first time that India Inc. and borrowers, in general, realized that not paying back the loans could lead to dispossession of their companies or their assets. The Code was applicable to all types of companies, except the banks. As the finance minister said, this was the first time that instead of the banks chasing the borrowers for recovering the loans, the borrowers were chasing the banks for ensuring that they first paid up and were not dragged to the courts under the Code.2 Of course, the government had to step in a
nd push the process by suitably amending the Banking Regulation Act.
The borrowers’ behaviour and their repayment discipline improved after the government issued a broad directive to the RBI under the Banking Regulation Act to initiate action against companies which had defaulted on loan repayments under the Insolvency and Bankruptcy Code. This paved the way for the RBI putting out periodic lists of companies that had become insolvent due to defaults on their loan repayment obligations. And many big promoters of India Inc. lost their companies through the process initiated under the Code and more were set to join that list. In a bid to make the process less vulnerable to misuse, the government also amended the Code to prevent promoters of all insolvent companies, except micro, small and medium enterprises (MSME), from bidding for their companies under the Code. Promoters of insolvent MSMEs were also debarred from the bidding process under the Code if they were declared wilful defaulters. The fear of losing a company was the biggest fallout of the Insolvency and Bankruptcy Code, even though its effectiveness would have been far greater, if the government had also simultaneously strengthened the capacity of the National Company Law Tribunals by setting up more benches to expedite the hearing of the insolvency cases. Nevertheless, its disruptive impact on India Inc. was huge.
Battle between RBI and the Government
Expectedly, there was a political backlash of such stringent measures against enterprises that failed to repay their loans. Enforcing tough measures against companies that defaulted on loan repayment, leading to their dispossession of companies that they helped set up, further strengthened the Narendra Modi government’s image that it was not too friendly to big business.
But there was pushback as well. Within months of the Insolvency and Bankruptcy Code swiftly deciding on liquidation of insolvent companies or their takeover by other business entities, the government began exploring alternative means to soften the blow. It began engaging with the RBI for extending preferential treatment for companies in some sectors that suffered from specific developments forcing them to default on their loan repayment obligation. When the RBI declined to make any concessions on enforcing its stressed assets recognition norms for any sectors, the matter went to court and the government supported the industry’s petition.
But the court asked the government to use provisions under the law to issue a direction to the RBI for making such a concession. That in many ways was the starting point of the RBI-government tiff over what approach should be adopted for resolving the economy’s twin balance-sheet problem. Separately, the government framed an alternative stressed asset resolution package for the power sector companies. The alternative scheme was to be implemented outside the purview of the Insolvency and Bankruptcy Code. Fortunately, that scheme did not make much headway.
The pushback to the RBI’s initiatives on the resolution of stressed assets came also from the Supreme Court. Borrowers aggrieved by the 12 February 2018 circular of the RBI moved the courts. They were unhappy with the RBI circular that laid down a strict time-bound recognition of stressed assets and their resolution plan. Less than a year later, in April 2019, the Supreme Court ruled that the 12 February circular of the RBI was unconstitutional, even though it stood by the insolvency resolution process under the Insolvency and Bankruptcy Code. It was a setback for the RBI’s initiatives on stressed assets resolution. The RBI had no option other than reframing its guideline to address the concerns raised by the apex court of the country.
What complicated the relationship between the RBI and the government was a Rs 11,400-crore credit scam that hit the state-controlled Punjab National Bank, where diamantaires, Nirav Modi and Mehul Choksi, had used the bank’s credit facilities to finance their projects without any collaterals or guarantees. Even as the Bank was engaged in its own efforts to recover dues from Nirav Modi and Mehul Choksi, the government put the blame on lax regulation of banks by the RBI and also introduced a new piece of legislation to facilitate criminal proceedings against economic offenders who became fugitives refusing to return to India and submit themselves to the arms of the law.3 RBI Governor Urjit Patel responded in defence of the central bank and argued that the extant law had not sufficiently empowered him to deal with the management of public-sector banks in the same way as the law allowed him to do for private-sector bank managements. In as many as seven areas, the regulation for public-sector banks under the Banking Regulation Act was different from that for other banks. For instance, he argued that the RBI could not remove directors and managements at the public-sector banks. It could not supersede their boards. It could not remove chairmen and managing directors of public-sector banks. It could not force a merger of a public-sector bank. It could not even revoke the licence for public-sector banks, since they do not actually need a licence from the central bank, quite unlike the private-sector banks. Nor could the central bank trigger the liquidation of public-sector banks.
Finally, the RBI governor said that the top managements of public- sector banks came under dual supervision—as they had the sovereign as their shareholder and had to keep their interests in mind and at the same time had to come under the supervision of the regulator.
What was the RBI governor’s prescription to remedy the situation? He asked for suitable amendments in the Banking Regulation Act. And all these suggestions were made by him in a public speech he delivered in Gandhinagar, Gujarat, on 14 March 2018. Patel had hit the nail on its head. Even the effectiveness of the Insolvency and Bankruptcy Code was likely to be impaired if the government failed to pay heed to the need for improving the governance standards in public-sector banks. Even after the Code helped these banks reclaim a part of their stressed loans, the questions of reforming the public-sector banks’ management structure, giving them functional autonomy and bringing them under a stricter regulatory regime, would continue to arise with alarming frequency.
The government did not come out with any response to the governor’s detailed critique on the weaknesses in the regulatory laws for public- sector banks. But it became clear that the relations between the RBI and the government were under stress. What started out as a stressed assets problem, largely for the public-sector banks, had aggravated to become a tussle between the regulator and the government. While the RBI showed determination in ensuring the enforcement of norms for recognition of bad assets for banks and their resolution, the government responded with a plan for recapitalization and reforms. But the surfacing of scams in public- sector banks and the government’s discomfort over the RBI’s refusal to show preferential treatment to some of the beleaguered sectors created fissures in the relationship between the two entities. The government had argued that a selective relaxation was necessary to boost investment, which had slowed down the economy, but the RBI was concerned over the long-term damage such relaxation would cause to the financial system. Differences between the government and the RBI were coming to the fore.
Even earlier, when Rajan was the RBI governor, the government’s relations with the central bank had become strained. On the one hand, Rajan would make public speeches that would criticize the government’s policies on manufacturing or even its performance. Rajan defended those speeches, but critics found that as the RBI governor, he should have refrained from making such comments that either criticized the government’s Make In India policy or compared the Indian economy’s growth performance to a one-eyed man becoming the king in the land of the blind. The government was not pleased with such statements and their relationship soured even as Rajan left the RBI on the completion of his three-year tenure in September 2016. Even while Rajan was in charge of the central bank, the government would gradually nibble away at the RBI’s powers and autonomy. The setting up of the Monetary Policy Committee was hailed as a bold reform, entrusting the task of formulating the monetary policy with a committee consisting of the RBI governor, representatives of the central bank and a few independent experts. But the task of appointing the independent experts for the committee was left to a government committee, h
eaded by the cabinet secretary with the RBI governor as one of the members. Similarly, the earlier freedom RBI governors would enjoy in appointing their deputy governors was gradually curtailed and brought under the discipline of an official appointments committee.
Strains in the relationship between the government and the RBI began surfacing in other areas as well. Larger questions of the central bank’s autonomy were raised and the government’s approach to the entire issue also came under attack, just as the central bank was criticized for bringing its differences with the sovereign out in the open, without trying to resolve them within the board room or through bilateral consultation with the finance minister. Deputy Governor Viral Acharya delivered a public speech in October 2018, where he forecast a grim scenario for any economy that did not heed the importance of preserving the autonomy of the central bank. Acharya’s speech was interpreted as a direct attack against the government, which had earlier cut short the tenure of one of the directors and appointed one who was politically sympathetic to the government.
The government chose to use Section 7 under the RBI Act to seek consultation with the RBI governor for some of these issues. While truce was called after a few rounds of meetings and no directions were required to be issued under the provision of the law, the relationship between the RBI and the government got strained and the resultant stress was a deeply worrying development. Eventually, on 10 December 2018, RBI Governor Urjit Patel decided to resign, citing personal reasons. The government took just a day to identify Patel’s successor—a retired IAS officer, Shaktikanta Das.
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