Giving power sector special dispensation on bad loans will be a retrograde step

On 20th August, Reserve Bank of India’s legal counsel will defend the central bank’s current regulatory framework which sets unambiguous deadlines for banks to recognize bad loans.

The context to the forthcoming hearing is a case filed in Allahabad High Court by power companies against a central bank circular which tightened the process by which banks deal with bad loans.

One of the likely implications of the circular is that a lot of power sector bad loans may be put through the insolvency process under the Insolvency and Bankruptcy Code.

The power sector’s bad loans constitute a large proportion of the overall bad loans. An analysis in Mint put the  quantum of stressed assets in the power sector at Rs 3.6 trillion.

What’s the main cause for this problem?

RBI answered this when it’s representative deposed before a parliamentary standing committee which studied the problems of the power sector.

According to the RBI representative:

“Certain principal areas which have resulted in stress for example the GENCOs due to a number of factors which are not necessarily linked so much to the finance as to expectations of certain cash flows which they were to get.”

The parliamentary standing committee’s report does suggest that a poor commercial decisions by both promoters and banks have contributed to the bad loan problem in power sector. The only way out is for both debt and equity holders to accept a loss. Coming up with another complicated scheme to postpone this loss is not a solution.

The bad loan issue has ramifications beyond the relevant accounts. One of the areas where it has a negative spillover is when Indian banks provide letters of credit to importers. The associated costs are influenced by the rating of banks.

The solution now is to go through the IBC, which is the Narendra Modi government’s best contribution to reforming the economic architecture. Carving out a special dispensation to help one sector will only dilute this reform.