India: Scheme For Sustainable Structuring Of Stressed Assets: RBI Takes The Leap Of Faith

In continuation of its policy to curb bad loans and arrest incipient stress in the system, the Reserve Bank of India (RBI) introduced a new scheme on June 13, 2016 titled the 'Scheme for Sustainable Structuring of Stressed Assets' (S4A Scheme), offering an alternative restructuring opportunity to lenders struggling with delinquencies in large accounts. The S4A Scheme is the latest entry in a series of initiatives introduced by RBI (the Reserve Bank of India) in the last twenty four months to tackle rising NPAs in the banking channels.

The key objective of RBI in driving this circular seems to stem from the difficulties faced by the banks and financial institutions in India in successfully invoking the Strategic Debt Restructuring Scheme issued by RBI in 2015 (SDR Scheme), which allows lenders to convert their outstanding debt to equity to take majority ownership and control of a stressed company and offers the lenders an 18 - month window to find a white knight willing and able to turn around the company and regularise the repayments.

Although, RBI had its heart in the right place while introducing the SDR Scheme and it offered certain immediate relief to the bleeding lenders, the SDR Scheme has been criticised by several market players as a NPA postponing exercise, as it leads to deferral of debt obligations (as the lenders end up acquiring majority control of the defaulting company by converting a fraction of debt to equity) rather than bringing the debt to sustainable levels. Additionally, lot of the stress cases involve companies which have also been hit by externalities (such as steel, EPC and power sector companies). In such cases, finding a new promoter willing to purchase the entire stake of a stressed company within 18 months was very difficult and impractical. Therefore, a need was felt to find an option where the lenders could reduce the debt to a level commensurate with its cash flows and even if that required working with the existing promoters to turn around the company.

It is in this backdrop and after due consultation with the lenders, the RBI formulated the S4A Scheme with the objective of deep restructuring of large accounts to revive projects, that are viable. The Scheme permits lenders to determine and segregate the debt into a 'sustainable debt' component (representing the loans which are capable of being serviced by the current cash flows of the company and representing not less than 50% of the current funded liabilities) and restructure the balance amounts into equity/ quasi-equity instruments which are expected to provide an upside to the lenders, in case of recovery.

In order to be eligible under the S4A Scheme, the lenders are required to ensure that the (i) account belongs to a project that has commenced commercial operations, (ii) aggregate exposure (including accrued interest) of all institutional lenders in the account exceed Rs 500 Crores (including, rupee loans, foreign currency loans, external commercial borrowings) and (iii) debt meets the test of sustainability. Although RBI has tried to extend the applicability of the Scheme to a large number of accounts by setting a de-minimis threshold as low as Rs 500 crores, a lot of accounts will be deprived of this beneficial regulation, for want of achieving commercial operations, particularly stressed cases in sectors like power, steel and roads, where projects are running behind schedule on account of delays in land acquisition and grant of regulatory and environmental approvals.

Recasting an account in terms of the S4A Scheme, involves the lenders appointing an independent agency, responsible for conducting a techno-economic viability report and determining the amount of sustainable debt. Following the determination of the 'sustainable debt', the lenders are required to formulate a resolution plan, which needs to be approved by a minimum of 75 per cent of lenders by value and 50 percent of lenders by number in the consortium.

The S4A Scheme offers a bouquet of options rather than adopting a one-size-fits-all approach. The lenders, while formulating a resolution plan may either chose to allow the promoter to continue with majority shareholding and control or replace the promoter in terms of the SDR Scheme (or, alternatively under the Prudential Norms on Change in Ownership of Borrowing Entities (Outside Strategic Debt Restructuring Scheme)) or exercise the conversion and permit the existing management to continue or bring in a professional management agency. In cases where the promoter is allowed to continue, the lenders have also been given the option to convert the non-sustainable debt into optionally convertible debentures.

While the S4A Scheme envisages reduction of debt to sustainable levels, it does not permit grant of fresh moratorium or extension of repayment schedule or reduction of interest rates. Therefore, the implementation of the S4A Scheme rests on the ability of the lenders to accurately determine levels of sustainable debt (not being less than 50% of the current funded liabilities) which can be repaid within the same timelines and interest rates and their appetite to take risks associated with equity investments.

As regards valuation at the time of conversion, the shares are required to be marked to market on a daily basis or at the least, on a weekly basis. While in case of unlisted companies or where quotations are not available, the banks are required to value the shares using the break-up value method or the commonly used discounted cash flow method. For redeemable cumulative optionally convertible preference shares/ optionally convertible debentures, the lenders are required to value such instruments by adopting the discounted cash flow method. In cases where the lenders opt to continue with the existing promoters, such persons will be required to dilute their shareholding in the company (either by way of issue of new shares upon conversion to the lenders or sale of promoters' shares to the lenders) at least in the same proportion as that of converted debt to the total debt. Promoters have also been mandated to furnish personal guarantees to ensure that they are motivated to service the debt and turn around the company, and ensure that their skin is in the game.

On the precautionary side, RBI has adopted a stricter provisioning norm for cases where the lenders permit the promoters to continue, in terms of the S4A Scheme. The lenders are required to provision, either 20% of the total outstanding debt or 40% of the amount that is considered sustainable, whichever is higher, in order to maintain a standard classification. However as a silver lining, a stand-still period of 90 days has been provided from the date of reference in order to enable the lenders to formulate the resolution plan and implement it. This will play out as an advantage for lenders, who have been maintaining higher provisioning on stressed assets.

In order to ensure transparency, the S4A Scheme requires the resolution plan to be ratified by an overseeing committee, set up by the Indian Banks' Association in consultation with RBI, comprising of eminent experts who would be responsible for reviewing and assessing the resolution plan. Though on one hand this works as an incentive for bank officers to take decisions and protects them from any liability in the future, the ratification period is not time bound. This may create difficulties for lenders specifically in situations where the lenders would like to use the S4A Scheme while determining the insolvency resolution plan under the new Insolvency and Bankruptcy Code, 2016 (the Insolvency Code). The Insolvency Code prescribes a strict time line of 180 days (extendable by another 90 days) for determination of the resolution plan from the date of admission of application for insolvency. Upon the Insolvency Code being notified, the lenders will have no option but to wait for the ratification, while the clock under the Insolvency Code shall have commenced ticking. In case the Overseeing Committee does not approve the resolution plan or suggests alterations, the lenders will have to scramble to come up with a more acceptable plan within the remaining time. Therefore, the working of the S4A Scheme will be tested once the Insolvency Code is implemented.

The jury is still out on whether the S4A Scheme will pan out like its predecessors or be a success. However, there is no denying that it emerges as an important tool in the hands of the bankers, offering them an opportunity to restructure on the basis of sustainable cash flows and improving their returns through equity upside upside post revival. Instead of making losses by selling assets to asset reconstruction companies at a discount or scrambling to sell 51% equity to a new promoter within 18 months, lenders will now be able to make their own assessment of sustainable debt and wait out till the company is revived to make higher profits in the long run, just like any other investor.

Only time will tell whether the market is still ripe for this sort of disruption and if this scheme will have any serious positive impact in resolving mounting NPAs in the banking system.

The content of this document do not necessarily reflect the views/position of Khaitan & Co but remain solely those of the author(s). For any further queries or follow up please contact Khaitan & Co at

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