Loan Restructuring: This Time is Different

Context: The latest attempt at loan restructuring is to stave off these dire possibilities and marks a reversal in the broad approach to tackling bad loans.

Trends of Non-Performing Assets since 1991: 

• Between 1996 and 2007: 

• The sector started off the post-reform phase with a ratio of gross non-performing assets (NPAs) to loans of 16.0% in 1996-97.

• Rapid economic growth and the reforms undertaken at public sector banks (PSBs) helped the sector recover solidly, and the NPA level had come down to 2.6% in 2007

• After 2008: The Global Financial Crisis, adverse court judgements and need for Asset Quality Review rose the NPA to 11% in 2017-18.
• In present times: 

• A determined effort at recognition and resolution brought the NPA level down to 8.5% by 2019-20.

• Impact of Pandemic: The pandemic has dealt a severe setback, with NPAs threatening to rise to 12.5-14.7%, according to the Reserve Bank of India’s (RBI’s) report.

Recent Measures taken by the RBI to check NPAs:

• One-time restructuring scheme: for Micro, Small and Medium Enterprises (MSMEs) started in January 2019 and has been extended to December 31, 2020, in the wake of the pandemic.

• The latest resolution plan came with several checks:

• Intended only for firms affected by the pandemic and will be applicable to firms not in default for more than 30 days prior to the cut-off date of March 31, 2020.
• All proposals above Rs100 crore will require validation by an independent agency.
• Proposals above Rs1,500 crore will be vetted by the K V Kamath committee appointed by the RBI.
• Loan tenures cannot be extended by more than two years under the resolution framework.
• The Kamath committee has specified parameters that resolution plans must adhere to 26 sectors.

• Suspension of Insolvency and Bankruptcy proceedings.
• Loan Moratoriums: The Indian Banks’ Association has offered a two-month moratorium on declaring any account as NPA at the end of the moratorium period on August 31.

• A new Resolution Framework: The latest resolution plan came with several checks:

• Intended only for firms affected by the pandemic and will be applicable to firms not in default for more than 30 days prior to the cut-off date of March 31, 2020.
• All proposals above Rs100 crore will require validation by an independent agency.
• Proposals above Rs1,500 crore will be vetted by the K V Kamath committee appointed by the RBI.
• Loan tenures cannot be extended by more than two years under the resolution framework.

Factors supporting the latest resolution framework: as opposed to the previous resolution plans which led to their failure.

• Presence of sustainable Provision Coverage Ratio (PCR): the PCR at banks has gone up considerably in recent years — from 48%in 2018 to 65% in 2020.
• Reduced incentives for the banks if loans are not restructured: 

• Market will take a dim view of banks that have a high proportion of restructured loans on their books.
• This will make banks keep restructured loans at under 5% of their loan books to stave off future losses. 

Judging the extent of required restructuring: following approaches can help - 

• One approach would be to not rush resolution plans, except for borrowers for whom default is imminent.
• Another would be to put in place agreements with borrowers that have an upside to repayments if recovery turns out to be stronger than forecast in the plans.

Challenges to the restructuring of loans:

• Interest change during moratorium: The matter of interest charged on loans during the moratorium period, which is pending before the Supreme Court, will have a bearing on loan restructuring.
• One approach would be to not rush resolution plans, except for borrowers for whom default is imminent.
• Political interference: Politicians are faulted for leaning on the RBI to practise regulatory forbearance.