Covid-19 Loan Resolution Framework

The collateral damage from the Covid-19 pandemic has, arguably, been and will be more devastating or at least as damaging, as the loss of lives and livelihoods the pandemic itself has caused. In the Indian context, one of most strict lock downs was put in place during March – April, 2020, to prevent immediate spread of the infection. One of the collateral damages has been the stress caused to the loan portfolios of Banks whose exposures to  Indian businesses, big and small, in both manufacturing and service sectors, that suffered almost total loss of revenue and liquidity for the period of lock downs and subsequent months when local restrictions and loss of confidence and fear are still preventing resumption of normal business activities.

The moratorium announced by RBI in April, 2020, was an emergency palliative to let borrowers avoid default. But as recognized by everyone involved, moratoria, however elongated, cannot be a cure. On the contrary, longer freeze of debt servicing would only make it worse, as interest for the period of moratoria cannot be wished away, much as people may hope to. In no time will the lenders’ capacity to service their deposits be affected shaking the very foundations of the economy.  Recognising this, government announced substantial relief measures to the MSME sector in June, 2020 through  debt restructuring, additional long term funding support to the lenders  and even equity support to entrepreneurs.

For other businesses, RBI devised a new framework [1]for management of stress in the asset portfolio of Banks. This framework comprises the following salient features.

1.       This framework is applicable to any financial stress caused ONLY due to Covid-19 pandemic and thus for a borrower to avail of the reliefs in this framework, the exposure of lenders to a borrower eligible otherwise, should have not been in default for more than 30 days on 1^st March, 2020.

2.       RBI had set the timelines for this framework earlier that the eligible borrowers should be identified latest by 31^st December,2020 and the resolution process should be completed within 90 days in case of personal loans and 180 days for non-personal loans,  from initiation. Further, ‘completion’ of the resolution has been defined –

a.       Completion of all the related documentation with the borrower and between lenders,

b.      The restructuring changes actually reflected in the books of the lender and

c.       Under the revised terms, borrower is not in default.

3.       The stress resolution plan can include

a.       moratorium,

b.       rescheduling of the repayment terms like number of installments,

c.       conversion of interest accrued and to be accrued into future installments, based on the assessed income streams of the borrower, extending up to two years.

d.      Conversion into equity any part of the outstanding debt or other marketable debt instruments

4.       In case of borrowers with multiple lenders, the resolution plan should be approved by all the lenders through an Inter Creditor Agreement (ICA) within 30 days from the day the plan is invoked. Further, if at least 60% of the lenders (75% by value) do not join the ICA within these 30 days, the resolution plan fails and there can be no other resolution under this framework, i.e., for Covid-19 caused stress.

5.        The ICA should also have mechanisms for redressing differences and disputes among the lenders and RBI will not interfere or arbitrate.  The resolution process will stop if any of the timelines are breached or any inter-lender disputes remain unresolved.

6.       An independent credit evaluation (ICE) by  a credit rating agency (CRA) is mandatory for approving resolution plans for aggregate exposure of 100 crores or more.

7.       Borrowers not covered in this framework are:

a.       MSME borrowers with aggregate exposure of 25 crores

b.      HFCs  where a restructuring  has already been done)

c.       Agricultural credit  and related intermediaries like Primary Agricultural Co-operatives

d.      Governments – central, state or local and corporate set up by an act of Parliament and undertakings

e.      Financial services providers.

 To quickly rollout the framework that Banks can implement, RBI set up a committee headed by K.V. Kamath,[2] ex- CEO of New Development Bank and ex-Chairman of ICICI Bank Ltd. to suggest sector-specific financial parameters  any other conditions for preparation of the RPs. This committee has also been mandated to validate and monitor implementation of the RP in case of borrowers with aggregate exposure of 1500 crores or more to ensure adherence to the framework without going into the commercial judgement of the lenders.

Highlights of the Kamath Committee are

1.       Looked at the sectors substantially funded by the banking sector and  impacted by the pandemic and classified the sectors into four categories –

a.       11 sectors like construction, auto, NBFC, etc. that had pre-existing stress and were also impacted by the pandemic

b.      19 sectors like retail and wholesale trade, cement, tourism and travel, that did not have any pre-existing stress but were impacted by the pandemic,

c.       2 sectors – telecom and tea that had pre-existing stress but were not impacted by the pandemic

d.      11 sectors like agri and allied products, food products, FMCG, that did not have any pre-existing stress and  were not severely impacted

Sectors were classified based on varying severity of impact - mild, moderate or severe. 

2.       The financial parameters that should be considered for preparing the RPs are

·         Total Outside Liability / Adjusted Tangible Net Worth (TOL / Adjusted TNW)

·         Total Debt / Earnings Before Interest, Depreciation, Tax and Amortisation(EBIDTA)

·         Current Ratio

·         Debt Service Coverage Ratio (DSCR)

·         Average Debt Service Coverage Ratio (ADSCR)

3.       Based on the severity of impact of the pandemic and exposure of the lenders, 26 business sectors have been identified with financial parameters to be considered for RP.

4.       The range for the financial parameters have been defined for these sectors with broad guidelines –

a.       The RP may be prepared based on the pre-Covid-19 operating and financial performance of the borrower and impact of Covid-19 on its operating and financial performance in Q1 and Q2FY21, to assess the cash-flows for FY21 / FY22 and subsequent years.

b.      The threshold TOL/Adjusted TNW and Debt/ EBIDTA ratios should be met by FY23.

c.       The other three threshold ratios, viz., CR, DSCR and ADSCR,  should be met for each year of the projections starting from FY22. The base case financial projections need to be prepared as part of RP.

d.      Lenders may determine their own range for other sectors for which the parameters have not been defined with the baseline parameters of CR and DSCR of 1.00 and ADSCR of 1.20.

5.       For a few sectors, exceptions have been defined based on the industry nature and practices  like

a.       Automobile sector that practices Just In Time (JIT) principle for inventory,

b.      aviation sector that finances its aircraft largely through debt refinancing and work cash & carry model for revenue, carry advances form customers and up to 9 months’ credit from vendors,

c.       Roads sector to which ratios like TOL / ATNW, Debt/EBITDA and Current ratio may not be relevant

d.      Wholesale trade that does not normally raise term debt and hence DSCR and ADSCR are not relevant.

e.      Real estate borrowers’ assessment should be based on individual projects.

With the broad guidelines on preparing the RPs and the specific parameters on which the borrowers may be assessed to prepare the RPs, the framework is ready for the lenders is ready to go.

There have been comments that the requirement of formation of ICA is impractical and would lead to delays. The Kamath committee has also mentioned about the efforts required in identifying eligible borrowers, assessing the impact of the pandemic, structuring the RP and coordinating with their lenders to form working ICA but has probably for lack of mandate, hasn’t suggested any relaxation of the timelines. Thus the lenders’ position is hardly enviable.

Apart from having to bear the heavy additional load of stress in their asset portfolio due to the pandemic in addition to several other challenges they face, they also have been gifted very tight timelines to devise and implement the RPs, the success or failure of which will impact them. And they have two monitors to deal with – RBI, the regulator which has also stated that compliance with these requirements ‘shall be assessed for all lending institutions as part of the supervisory review’ and the Kamath committee to oversee RP implementation in case of large borrowers. One thing is for sure - Indian Banking is a sector that will be under very close scrutiny both within and from outside, in public and private, for the foreseeable future.

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[1] https://www.rbi.org.in/Scripts/NotificationUser.aspx?Id=11961&Mode=0

 [2] https://www.rbi.org.in/Scripts/PublicationReportDetails.aspx?UrlPage=&ID=1157