Andy Mukherjee is a Bloomberg Gadfly columnist covering industrial companies and financial services. He previously was a columnist for Reuters Breakingviews. He has also worked for the Straits Times, ET NOW and Bloomberg News.

Although Raghuram Rajan co-wrote the influential 2003 book, "Saving Capitalism From the Capitalists," it has fallen upon his successor at the Reserve Bank of India to actually attempt such a thing. By the looks of it, Urjit Patel has a hard slog ahead.

For now, the governor of India's central bank can breathe a sigh of relief. His most audacious plan yet for cleaning up a $191 billion bad-debt mess jumped over a crucial legal hurdle on Monday. Yet the judgment of the Gujarat High Court in Essar Steel India Ltd. vs. the RBI is so unflattering to the banking regulator -- and so portentous of the looming battle with business families -- that Patel might wonder if the victory is worth celebrating.

Here's a plot summary: The RBI in June asked Indian lenders to initiate bankruptcy proceedings against 12 large corporate accounts, which collectively comprise a quarter of their soured assets. Essar Steel, controlled by the billionaire Ruia family, objected to its inclusion in that list of the distressed dozen, and termed the central bank's directive as "hostile, arbitrary and unreasonable."

Getting Better? Hardly
Essar Steel's bad debts now exceed $5 billion. That's 97 percent of its total obligations
Source: High Court of Gujarat

Essar argued that while it does have $5 billion in nonperforming debt, the steel business is coming out of a multiyear funk, plus it's negotiating a restructuring deal with lenders. At this juncture, handing over the management to a tribunal-appointed insolvency professional would shut down operations and unnecessarily make matters worse.

The court dismissed Essar's plea, leaving it to the company-law tribunal to decide if it wants to admit Essar into bankruptcy, or give it more time to negotiate with creditors, including State Bank of India and Standard Chartered Plc.

The judge, though, came down hard on the RBI for asking the tribunal to accord priority to the top 12 cases. The banking regulator has no business offering "advice, guidelines or directions to judicial or quasi-judicial authorities in any manner whatsoever," the order said.

More than that rap on the knuckles, what ought to annoy Patel is the court's observation that "it would be appropriate for RBI to see that the benefit of all its schemes is equally offered and extended to all without any discrimination."

That sentence appears innocuous, but has the power to allow errant debtors to hang on to their assets indefinitely. After all, the restructuring Essar is seeking falls under the so-called Scheme for Sustainable Structuring of Stressed Assets, or S4A. Since this is also an RBI initiative, the central bank may have a hard time explaining in a court of law why it's pushing banks to shove only some accounts into bankruptcy while letting others renegotiate.

End of Exuberance
Indian state-run lenders' shares had a good summer after the central bank was given new legal powers to resolve a knotty bad-loan problem; but investors' enthusiasm is waning
* Shows market capitalization-weighted index of 19 state-run lenders.

In early May, the Indian government empowered the central bank to instruct lenders on resolving individual cases of distress. Stocks of state-run lenders, which dominate the country's banking landscape and are carrying the bulk of nonperforming assets, jumped. This was an important shift in strategy because the lenders, unsure of recapitalization and wary of criminal investigation, were unwilling to take large hits on their bad-loan piles without any hand-holding.

Gadfly, however, noted that the one-year-old bankruptcy law was untested; besides, influential families that control large companies won't meekly give up what they consider to be their property. Sure enough, investor enthusiasm is starting to ebb. 

Saving capitalism from the capitalists proved too much for Rajan. If the Gujarat court order is any guide, Patel won't have it any easier.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

  1. The court order notes that Essar had, in January, proposed to repay StanChart at the end of 25 years. Until then, it has offered 1 percent annual interest. StanChart, which gave an Essar unit a $413 million offshore loan in 2014, has approached the bankruptcy tribunal separately from the State Bank of India-led consortium of onshore creditors.  

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