MC: Digging Deeper | What does RBI’S revised framework for resolution of stressed assets look like?

18 June 2019: On June 07, 2019, post the quashing of its ‘revised framework for resolution of stressed assets’ by the Supreme Court in April, multiple media sources reported that the Reserve Bank of India had issued a ‘prudential framework for resolution of stressed assets’, giving lenders leeway to review a borrower account within 30 days of default.

However, as Hindu Business Line reported, it stipulates additional provisions in case of delayed implementation of the resolution plan (RP).

On this edition of Digging Deeper with Moneycontrol, we will explore the new framework that gives lenders a breather from the one-day default rule whereby they had to draw up an RP for implementation within 180 days of the first default.

New approach

The new framework gives lenders (scheduled commercial banks, all-India financial institutions and small finance banks) 30 days to review the borrower account on default.

As media sources have reported, during this review period, lenders may decide on the resolution strategy, including the nature of the RP and the approach for its implementation. Lenders may also choose to initiate legal proceedings for insolvency or recovery.

The RBI circular says that since default with any lender is a lagging indicator of financial stress faced by the borrower, it is expected that the lenders initiate the process of implementing an RP even before a default.

We quote Hindu Business Line, ” While the defunct circular was applicable only to Scheduled Commercial Banks (excluding Regional Rural Banks) and all-India financial institutions, the new circular is also applicable to small finance banks and systemically important non-deposit taking non-banking financial companies (NBFCs) and deposit-taking NBFCs.

In cases where the RP is to be implemented, all lenders have to enter into an inter-creditor agreement (ICA) for the resolution of stressed assets during the review period to provide for ground rules for finalisation and implementation of the RP in respect of borrowers with credit facilities from more than one lender.”

Business Line explains that under the inter-creditor agreement or ICA, any decision agreed to by the lenders representing 75 per cent of total outstanding credit facilities by value and 60 per cent by number will be binding upon all the lenders. In particular, the RPs will provide for payment which will not be less than the liquidation value due to the dissenting lenders.

The piece further goes on to elucidate, in cases where the aggregate exposure of a borrower to lenders (scheduled commercial banks, all-India financial institutions and small finance banks) is ₹2,000 crore and above, the RP has to be implemented within 180 days from the end of the review period, and the reference date has been set as June 7, 2019.

In the case of borrowers in the ₹1,500 crore and above but less than ₹2,000 crore category, January 1, 2020 has been set as the reference date for implementing the RP. In the less than ₹1,500 crore category, the RBI will announce the reference date in due course.

More provisions

Furthermore,  if the implementation of an RP crosses the stipulated 180 days from the end of the review period, the lenders have to make additional provisions of 20 per cent of the outstanding loan. If this timeline exceeds 365 days, they further have to make a provision of 15 per cent.

These additional provisions are over and above the provisions already held or the provisions required to be made as per the asset classification status of the borrower account.

Business Line reports that Ramnath Pradeep, former Chairman & Managing Director of Corporation Bank, said the circular is silent on the role of NBFCs in the implementation of the RP in case they report a borrower as being in default and the role of borrowers.

Here in any case is what  the circular says in a nutshell:

  • Lenders will get a breather from the one-day default norm.
  • They will get a 30-day review period to frame a resolution strategy.
  • They have to submit a weekly report to the RBI on defaults by borrowers with exposure of ₹5 crore and above.
  • New norms also applicable to small finance banks and large NBFCs.

Updation and revisions

Just to jog your memory a bit, in February 2018, RBI had issued a framework on resolution of stressed assets under which banks were asked to initiate resolution or restructuring of loans worth Rs 2,000 crore or more even if there was a single day of default.

However, the Supreme Court had called this framework ‘ultra vires’.  Following this, RBI has revised the circular.

According to an earlier report by Money Control, RPs involving restructuring or change in ownership in respect of accounts where the aggregate exposure of lenders is Rs 100 crore and above, will require independent credit evaluation (ICE). This ICE of the residual debt has to be done by credit rating agencies (CRAs) specifically authorised by RBI.

RBI said that if the borrower fails to demonstrate satisfactory performance during the monitoring period, asset classification upgrade will be subject to implementation of a fresh restructuring/ change in ownership under this framework.

The Money Control also reported that according to the central bank, borrowers who have committed frauds or wilful default will remain ineligible for restructuring. However, in cases where the existing promoters are replaced by new promoters, the lenders can take a view on restructuring such accounts based on their viability. This has to be done without prejudice to the continuance of criminal action against the erstwhile promoters.

A closer look

On June 10, 2019, Madhavan Narayanan wrote in First Post an analytical piece that argued how the  central bank must frame stronger guidelines to police borrowers, not just lenders.

And this is what he began his argument with, “On the face of it, the Reserve Bank of India’s (RBI) new norms to offset a Supreme Court ruling against its February circular that stalled its attempts to fix the resolution of stressed loans seem like a pragmatic way to balance the needs of growth with prudent banking. But look hard, and you will find that the central bank has a long way to go in putting the system back on the rails. Questions lurk in the woodworks on how to future-proof India’s public sector banking system in a manner that would prevent the recurrence of a toxic cocktail of reckless lending, outmoded monitoring and crony capitalism. Between the struck-down circular and the diluted new regime, another significant event has occurred: the re-election of Prime Minister Narendra Modi’s BJP-led government. What this means is that there is a continuity in the administration in which blaming the predecessor is not an option, while there is also a need to plug the holes that have arisen in the process of managing stressed assets and the Insolvency and Bankruptcy Code (IBC).”

The writer goes over the revised set of norms asking lenders to take an early review of borrower accounts within 30 days of default and to get into an inter-creditor pact to implement a resolution plan within 180 days from the end of the review period. And the fact that the lenders may initiate legal proceedings for insolvency or recovery of loans. All that sounds a bit bureaucratic though pragmatic, he says and adds that though, it lays down a desirable road map, still the elephant in the room is the behaviour of borrowers.

It is time, he says, the RBI looked hard at what needs to be done in the entire process chain of borrowing, including issues related to collaterals, cash flows and above all the expected conduct of borrowing entities. He goes on to state that it is unfair to put the onus of supervision on banks without a complementary practice where borrowers need to be classified as good, bad and ugly and punished and rewarded accordingly.

He also reminds that just a day before the central bank unveiled its norms for stressed asset resolution, RBI governor Shaktikanta Das, evidently the PM’s chosen man for the job, announced a third successive interest rate cut, only to find the Sensex tanking by 500 points because mortgage lender Dewan Housing Finance Corporation Ltd (DHFL) faced a credit rating downgrade that upset the market mood.

We quote, “The harsh fact is that RBI’s problems have now also become that of stock market regulator Securities and Exchange Board of India (SEBI) because some Indian promoters such as the Essel group and DHFL have been cleverly using mutual funds to borrow funds.

The ghost of RBI”s pursuit of turning the heat on non-cooperative borrowers, who play hide-and-seek with banks despite their ability to repay hangs in the backdrop. Nirav Modi is now the dubious icon of banking frauds and Vijay Mallya for wilful defaulters, while Jet Airways founder Naresh Goyal stands on the margin in a tug-of-war over its future even as the grounded airline’s employees rise in protest, seeking government intervention.”

The writer also recalls how on the same day that Das was revealing revised norms for stressed assets, Maharashtra chief minister Devendra Fadnavis declared publicly that the government will take action against banks that refuse loans to farmers.

It is clear, says the piece,  that India’s public sector banks can neither go back to the “loan mela” culture of the 1980s nor afford to repeat the mistakes of the last decade that has resulted in a Rs 10 lakh crore pile-up of non-performing assets (NPAs). But neither can they   blindly follow the Western style of letting banks or companies fail as if it is business as usual because social pressures and the opportunity costs of corporate failures cast an impact on growth and jobs. The piece informs that a study last year estimated, the public sector banks (PSBs) account for 70 percent of loans but 87 percent of bad loans. We cannot apply a simplistic market-based approach in such a context, says the writer.

We quote, “The only reasonable way out seems to be a system in which banks can create a process of disclosures and behaviour mapping in which there is an onus on borrowers to keep the banks informed on forthcoming events and cash flow situations. Why should the economy wait for banks to spot the bad apples and lead the resolution amid judicial hurdles? Court cases linked to stressed assets and the IBC point out the need for the RBI to be smart in a manner that would prevent a judicial gaming of loans. It logically follows that taxpayers, depositors and safe borrowers should not be bearing the burden of defaulters and gamesters in an inter-connected system. This requires a rule and behaviour-based lending regime because old rules based strictly on collateral can inhibit loan growth vital for the economy.

From all indications, such a transparent regime is lacking in India. If necessary, the government should consider strengthening the Banking Regulation Act that was cited in the case that led to the Supreme Court striking down the February circular.”

However the piece  offers an optimistic view of the future. And foresees a time when  new technologies will bring branches, officers and lenders into a common information system to give dashboard views for quick action. As he says, “If Amazon can give discounts and cashbacks to buyers based on desirable behaviour, why can’t banks pick a leaf out of that and adapt that to borrowers?”

Still, he concludes on a cautionary note, “Borrowers must be held accountable in a manner that would curb a nexus between officers and bad borrowers on the one hand while minimising chances of borrowers resorting to courts to get away with defaults or unacceptable payment delays.”

As reported on moneycontrol

Categories: Legal update

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