Banks in this era are not just economy's payment and settlement system. They are more than mere agents and lubricate the wheels of real economy giving it a fast pace. India, being one of the fastest growing economies, needs a strong backbone to support the growth. Banks have played the major role in this by encouraging entrepreneurs, corporate houses to explore more and more business options and have been extending credit flow.
However, the banks have limitation in extending the credit flow, as the credit growth and survival of banks depend on its Balance Sheet and the asset quality represented by it. An asset is declared as nonperforming asset (NPA) by banks if it ceases to generate income for it i.e. principal and advance due on loans and advances are not paid by the borrower for a period of more than 90 days. The Reserve Bank of India has introduced certain norms from time to time to bring about greater transparency, consistency and certainty for the banks and various sectors. Such prudential norms include income recognition, asset classification, provisioning for advances etc.
A growth in economy has seen accelerated growth in NPAs making it crucial for the banks to manage their assets. Whenever an entity fails in their payment terms banks gear towards harsh roads of Securitization & Reconstruction of Financial Assets and Enforcement of Security Interest act, 2002 or file petition to Debt Recovery Tribunal against such an entity. As a result most entities are left with no other option but to wind up and to lose their identity.
In order to avoid such a situation and that the alarm bells be raised at the early stages itself a need has been felt that the banks recognize financial distress at an early stage and take prompt steps to resolve it. Accordingly, Reserve Bank of India (RBI) has formulated a 'Framework for Revitalising Distressed Assets in the Economy' for the banking system through its circular dated July 1, 2014. This framework ensures a fair recovery for lenders and investors and also helps to distinguish between viable and unviable accounts. These guidelines are applicable for lending under Consortium and Multiple Banking Arrangements. The highlights of these guidelines have been discussed below:
IDENTIFICATION OF SPECIAL MENTION ACCOUNT(SMA)
The banks are required to identify the creeping stress in the loan account, before it turns into NPA. For this, the accounts are to be categorized by creating three sub-categories under Special Mention Account (SMA):
Vide circular dated February 13, 2014 by RBI, the banks are required to report credit information, including classification of an account as SMA, on all their borrowers having aggregate fund based non-fund based exposure of RS.50 million and above, to 'Central Repository of Information on Large Credits' (CRILC), a set up by the RBI to collect, store and disseminate credit data to lenders.
FORMATION OF JOINT LENDERS' FORUM (JLF)
The Banks are required that as soon as an account is reported as SMA-2 i.e. principal or interest payment overdue between 61-90 days to CRILC, they should mandatorily form a committee to be called as Joint Lenders' Forum (JLF) if the aggregate exposure (AE) of lenders in that account is Rs 1000 million and above. Lenders have the option to form JLF even if the AE in an account is less than Rs. 1000 million and/or when account is reported SMA-0 or SMA-1.
The existing Consortium Arrangement will serve as JLF and the lender with the highest AE will convene JLF at the earliest. It is also possible that on substantiated grounds shown, the borrower may itself request the lender/s for formation of a JLF account.
All the lenders should formulate and sign the JLF Agreement incorporating the broad rules for its functioning. Further it should explore the irregularities/ weaknesses of the borrower and take necessary steps to set it right.
The RBI has also advised banks that in case the lead bank of the consortium or the bank with the largest aggregate exposure under the multiple banking arrangement fails to convene JLF within 15 days of reporting SMA – 2 status, then the bank with the second largest aggregate exposure shall convene the JLF within the next 15 days.
CORRECTIVE ACTION PLAN (CAP) BY JLF
CAP is a layout of a plan by JLF specifying how to resolve the stress in an account. Instead of settling on a particular resolving option, CAP explores various options like Rectification, Restructuring and Recovery.
- Rectification- The JLF, without any change in terms and conditions of the loan, may obtain a specific commitment from the borrower, so that the account comes out of SMA and does not slip into the NPA category.
Restructuring- If JLF considers that prima facie the account of the borrower is viable and he is not a willful defaulter, JLF may consider the possibility of restructuring the account. A restructured account is one where the bank, for economic or legal reasons relating to the borrower's financial difficulty, grants to the borrower concessions that the bank would otherwise not consider.
It involves modification of terms of the advances/securities, alteration of repayment period/repayable amount/ the amount of installments/rate of interest.To give a legal basis to this, a Debtor Creditor Agreement between the lender and the borrower is entered into. Also lenders sign among themselves an Inter Creditor Agreement (ICA). Any deviation from the commitment by the borrowers shall be the valid ground for initiating recovery process against him.
Recovery-Recovery process is the last resort when the above two options are not feasible. The best option available under the legal framework shall be adopted by JLF.
The JLF is required to arrive at an agreement on the option to be adopted for CAP within 30 days from:
- the date of an account being reported as SMA- 2 by one or more lender, or
- receipt of request from the borrower to form a JLF. The JLF should sign off the detailed CAP within the next 45 days from the date of arriving at such an agreement.
RESTRUCTURING OF ADVANCES BY BANKS
The basic objective of restructuring is to preserve economic value of assets, not ever-greening of problem accounts (i.e.NPAs). This can be achieved by banks and the borrowers only by careful assessment of the viability, quick detection of weakness in accounts and a time-bound implementation of restructuring packages. The Reserve Bank of India has formulated a comprehensive part in its guidelines to regulate the restructuring of advances the highlights of which are discussed below:
- Banks may restructure the accounts classified under 'standard', 'sub-standard' and 'doubtful' categories;
- In order to finalize the restructuring plan, at least 75% of creditors by value of loan and 60% by number of lenders in the JLF must agree to the plan;
- Banks cannot reschedule/restructure/renegotiate borrower's accounts with retrospective effect. The asset classification status as on the date of approval of restructured package by the competent authority would be relevant;
- Normally, restructuring cannot take place unless alteration/changes in the original loan agreement are made with the formal consent/application of the debtor;
- No account will be taken up for restructuring by the banks unless the financial viability is established and there is a reasonable certainty of repayment from the borrower, as per the restructuring package. The viability should be determined based on benchmarks like Return on Capital Employed, Debt Service Coverage Ratio, Cost of Funds etc;
- Borrowers indulging in frauds and malfeasance (termed as 'wilful defaulters') shall remain ineligible for restructuring. The restructuring of such cases may be done with Authority's Approval;
- The NPAs, upon restructuring, should be upgraded (in terms of asset classification) only when all the outstanding loan/credit facilities in the account are serviced as per restructured package;
- Banks will hold provision against the restructured advances as per the norms.
WHAT IS PROVISION ON RESTRUCTURED ADVANCES
Reduction in the rate of interest and/or rescheduling of the repayment of principal amount, will result in diminution in the fair value of the advance. Such diminution in value is an economic loss for the bank and will have impact on bank's market value of equity. It is therefore, necessary for the banks to measure such diminution and make provisions for it by debit to Profit & Loss Account.
- The banks should decide on convertibility option whereby the banks/FIs shall have the right to convert a portion of the restructured amount into equity;
- All restructuring packages must incorporate 'Right to recompense';
- A Clause based on the performance criteria of the borrower;
- To ensure promoters' commitment to the restructuring package, promoters' personal guarantee should be obtained;
- Banks should disclose in their published annual Balance sheets, under "Notes on Accounts", information relating to number and amount of advances restructured;
In cases where banks fail to report SMA status of accounts to CRILC or intentionally conceals the actual status of the accounts or evergreen the accounts, banks will be subjected to accelerate provisioning (i.e. debiting its Profit & Loss Account) for these accounts and/or other supervisory actions as deemed appropriate by RBI.
It is thus very much evident from these norms that RBI wants the banks/FIs to take effective measures before an account is declared NPA. This has somehow reduced the apprehension among the entities which were otherwise living in fear of winding up during unfavorable times.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.