The emergence of COVID-19 has impacted our country in many ways, one of such incidents is resolution of stressed assets. In this article we will do a deep dive to understand the impact, measures and possible mitigation on stressed assets resolution during and post pandemic.
What is Stressed Assets?
Stressed assets are powerful index of the health of the banking system. Stressed assets are typically the combination of the non-performing assets, restructured loans and written off assets. Stressed Assets generally face the issue of decrease in value due to market volatility and increase in default rates. The ongoing pandemic has resulted into large scale market instability and this may result in many Stressed Assets.
Emergence of June 7 Circular:
Our Central Bank has been issuing various notifications and circulars from time to time in order to mitigate the issues arising out of Stressed Assets in the banking industry. Prior to introduction of Prudential Framework of Stressed Asset dated June 7, 2019 ("Prudential Framework" and popularly known as June 7 Circular), the resolution of Stressed Assets was dealt by Reserve Bank of India (RBI) from time to time by introducing:
- Corporate Debt Restructuring Mechanism (CDR) in 2001,
- Joint Lending Forum (JLF) and Corrective Action Plan (CAP) mechanism in January 2014,
- Flexible Structuring of Long-Term Project Loans to Infrastructure and Core Industries (5:25 Scheme) in July 2014,
- Strategic Debt Restructuring Scheme (SDR) in 2015,
- Scheme for Sustainable Structuring of Stressed Assets (S4A) in 2016, and
- Resolution of Stressed Asset- Revised Framework in February 2018 (February 12 Circular).
The Supreme Court of India struck down the February 12 Circular, containing the revised framework for resolution of Stressed Assets, on the ground of it being ultra vires to Section 35AA of the Banking Regulation Act, 1949 and did not satisfy Section 45L of the Reserve Bank of India Act, 1934, as it excluded Non-Banking Financial Institution from the ambit of the impugned circular. Presently June 7 Circular is followed by the banking industry to resolve the Stressed Assets outside the IBC mechanism and enforcement process.
COVID-19 Economic Stimulus Package by Government of India:
The economic stimulus package was announced by Government of India in order to ease the effects of pandemic and provide a boost to economy, through credit guarantee, economic reforms that also includes proposed amendments and ordinance to the Insolvency and Bankruptcy Code 2016 ("IBC") collectively referred as ("Stimulus Package"). It has raised minimum threshold limit for initiating insolvency under Section 4 of IBC from Rs. 1,00,000 (Rupees One Lakh) to Rs. 1,00,00,000 (Rupees One Crore), with an objective to insulate the Micro, Small and Medium Enterprises ("MSME"). Stimulus Package has suspended fresh initiation of insolvency proceedings upto one year depending upon the pandemic situation and it also proposes for special insolvency resolution framework for MSME under section 240A of the IBC. Stimulus Package aims to empower the Central Government to exclude COVID-19 related debt from the definition of 'default' under IBC for the purpose of triggering insolvency proceedings.
COVID-19 Measures by RBI:
Due to national lockdown and widespread pandemic it was difficult for the banking industry to resolve the ongoing resolution process as well as initiating action under June 7 Circular. In view of the difficulties faced by the banking industry RBI has issued COVID-19 regulatory packages with relaxations from regulatory compliances for Stressed Asset restructuring, under the Prudential Framework. The relaxations were announced with objective to mitigate the burden of debt servicing brought about by disruptions on account of COVID-19 pandemic and to ensure the continuity of viable businesses. RBI on March 27, 2020, April 17, 2020 and May 22, 2020 has announced the following measures:
- COVID-19 Regulatory Package, (RBI/2019-20/186, DOR.No.BP.BC.47/21.04.048/2019-20), dated March 27, 2020 ("Regulatory Package I");
- COVID-19 Regulatory Package - Asset Classification and Provisioning (Ref: RBI/2019-20/220 DOR.No.BP.BC.63/21.04.048/2019-20) (Asset Provisioning Circular), dated April 17, 2020 ("Regulatory Package II");
- COVID19 Regulatory Package - Review of Resolution Timelines under the Prudential Framework on Resolution of Stressed Assets, (Ref: RBI/2019-20/219 DOR.No.BP.BC.62/21.04.048/2019-20), dated April 17, 2020 ("Regulatory Package III"); and
- Prudential Norms on Income Recognition, Asset Classification
and Provisioning Pertaining to Advances - Projects under
Implementation, (Ref: RBI/2019-20/216
DoR. NBFC (PD). CC.No.110/03.10.001/2019-20), dated April 17, 2020 ("Regulatory Package IV")
- COVID-19 - Regulatory Package (RBI/2019-20/244
DOR.No.BP.BC.71/21.04.048/2019-20), dated May 23, 2020 and COVID19 Regulatory Package - Review of Resolution Timelines under the Prudential Framework on Resolution of Stressed Assets (RBI/2019-20/245 DOR.No.BP.BC.72/21.04.048/2019-20) dated May 23, 2020 (collectively referred as "Regulatory Package V")
hereinafter collectively referred as ("Regulatory Packages").
RBI directed all commercial banks (including Small Finance Banks, Local Area Banks and Regional Rural Banks), Primary (Urban) Co-operative Banks/State Co-operative Banks/ District Central Co-operative Banks, all-India financial institutions and non-banking financial companies ("NBFC") including housing finance companies (collectively referred as "Lenders"), to pass on the relaxations under the Regulatory Packages to the borrowers, to ensure business continuity and ease the economic hardship due to impact of COVID-19.
Analysis of the Measures by RBI
Classification of Special Mention Account (SMA) and Non-Performing Asset (NPA)
Regulatory Package I permitted all the Lenders to grant a moratorium of three months on payment of all term loan instalments falling due between March 1, 2020 and May 31, 2020, and by virtue of Regulatory Package V, RBI has further extended the moratorium till August31, 2020 (collectively the "Moratorium Period") as well as to defer the recovery of interest applied in respect of working capital facilities sanctioned in the form of cash credit/ overdraft during the period from March 1, 2020 up to August 31, 2020 ("Deferment Period"). Further the Regulatory Package I and V also allowed the Lenders to recalculate the 'drawing power' by reducing the margins and/or by reassessing the working capital cycle in relation to the working capital facilities sanctioned in the form of Cash Credit ("CC")/Overdraft ("OD") to borrowers. The RBI further clarified that the moratorium and deferment (provided to the borrowers to tide over the financial difficulty due to the pandemic) shall not be treated as concession or change in terms and conditions of loan agreements due to financial difficulty of the borrower under the Prudential Framework, it shall not lead to asset classification downgrade. RBI has taken necessary step by clarifying that the Moratorium Period/ Deferment Period shall be excluded from supervisory reporting and reporting to Credit Information Companies ("CICs") by the Lenders. Further RBI has also instructed the Lenders that rescheduling of payments will not qualify as a default for the purposes of supervisory reporting and reporting to CICs by the lending institutions so that the credit history of the beneficiaries do not get impacted adversely. This measure by RBI would ensure that loans are not downgraded and consequent thereto the accounts will not be classified as a Stressed Asset either under SMA-1 accounts (overdue between 31(Thirty One) days and 60 (Sixty) days) or SMA-2 accounts (loan repayments overdue with delay of 61-90 (Sixty One- Ninety) days).
Regulatory Package II has clarified that all accounts which were standard assets prior to March 1, 2020 or on February 29, 2020, are excluded from the number of days past-due for the purpose of asset classification under the Prudential Norms. Therefore, classification of term loan shall be determined on the basis of revised due dates and the revised repayment schedule, after the Moratorium Period. Similarly, for working capital facilities/cash credit facilities that have been granted deferment of interest for the Deferment Period, shall be evaluated considering the application of accumulated interest for the period as well as with revised terms.
It is pertinent to note that NBFCs have been instructed to comply with Regulatory Package II, but they are also required to comply with Indian Accounting Standards ("IndAS") and continue to be guided by the guidelines duly approved by their Boards and ICAI Advisories for the recognition of impairments. Regulatory Package IV has extended the benefit of revised guidelines for deferment of Scheduled Commercial Operation Date ("SCOD") for projects in non-infrastructure and Commercial Real Estate ("CRE") sectors to NBFCs. The guidelines allow the NBFCs to extend the repayment schedule of loans to CRE and projects in non-infrastructure by additional one year, over and above the one-year extension permitted in normal course, if the reasons for the delay in SCOD are beyond the control of promoters. NBFCs can retain the 'standard' asset classification without treating the same as restructuring.
The Regulatory Package II has also addressed for making general provisioning of not less than 10% in two phases over two quarters (up to 5% each for quarters ending March 31, 2020 and June 30, 2020) for those accounts which were not in default on February 29, 2020, and classified as 'standard asset'. The provisioning can be adjusted against actual provisioning requirements for slippages from the accounts reckoned for such provisions and residual provisions can be written back or adjusted at the end of the financial year. The RBI instructed the Lenders to maintain all other provisions, for accounts that were classified as NPA as on February 29, 2020, as well as subsequent ageing in such accounts in the usual manner.
Disclosure in Financial Statement
Regulatory Package II requires Lenders to suitably disclose the details of the 'Notes to Accounts' while preparing their financial statements for the half year ending September 30, 2020 as well as the financial years 2019-20 and 2020-2021. They are required to suitably disclose the respective amounts in SMA/overdue categories, where moratorium and deferment was extended and where asset classification benefits are extended.
Relaxation in Review Period and Resolution Period
The Regulatory Package III and V together have relaxed the compliance of Review Period, under the Prudential Framework, that mandated all accounts to be reviewed by Lenders for period of 30 (Thirty) days (Review Period) from the day of default, the resolution plan is to be implemented with 180 (One Hundred Eighty) days (Implementation Period) from the completion of Review Period. The Regulatory Package III and V have excluded the accounts which were within the Review Period as on March 1, 2020 to August 31, 2020, from the calculation of the 30-day timeline for the Review Period. Therefore, all such accounts, the residual Review Period shall resume from September 1, 2020, upon expiry of which the Lenders shall have the usual 180 (One Hundred Eighty) days for resolution. Further, in respect of accounts where the Review Period was over, but the 180 (One Hundred Eighty) day resolution period had not expired as on March 1, 2020, the timeline for resolution shall get extended by 180 (One Hundred Eighty) days from the date on which the 180 (One Hundred Eighty) day period was originally set to expire. This measure will provide much needed respite to the Lenders, by providing additional time for restructuring and reviewing accounts during pandemic.
Impact Analysis of Regulatory Package
Classification of Special Mention Account (SMA) and Non-Performing Asset (NPA)
The Regulatory Package I expressly provided that moratorium and deferment shall not be construed as restructuring nor downgrading of asset classification. But it did not address the issue of ageing of those accounts which were already in default on February 29, 2020 or prior to March 1, 2020, for NPA classification. It excluded the application asset classification norms of under the Prudential Framework. It led to multiple litigation in NPA and SMA classification, in various High Courts. For example, the Delhi High Court in the matter in the case of Anant Raj Limited v. Yes Bank Limited1 held that moratorium and deferment shall be applicable on ageing account that are in default prior to Moratorium Period. Similarly, the Bombay High Court in the case of Transcon Skycity Private Limited & Ors. v. ICICI Bank & Ors.2 and Transcon Ironica Private Limited & Ors. v. ICICI Bank & Ors.3 held that moratorium during which there is a lockdown will not be reckoned by ICICI Bank for the purposes of computation of the 90 (ninety) day NPA declaration period. Therefore, in light of the above judicial pronouncement and to maintain consistency with Basel Committee clarification, RBI came up with Regulatory Package II, III and IV, for avoidance of multiple interpretation of relaxation norms.
Asset classification by Lenders
The Regulatory Package II and V together have specifically provided the moratorium and deferment which is intended to ease the pressure from borrowers in debt servicing due to COVID-19, and Lenders would not have to worry about any further on asset classification downgrade and review accounts for restructuring on default during Moratorium Period and Deferment Period. But it has failed to address the issue of asset classification/ ageing of accounts which are already in default prior to the commencement of Moratorium Period or Deferment Period. According to the asset classification guidelines under the Prudential norms on Income Recognition, Asset Classification and Provisioning pertaining to Advances ("Prudential Norms")4, ageing of a payment for 90 (Ninety) days from the due date would lead to an automatic downgrade of such assets to non-performing asset (NPA) category.
NBFCs under Regulatory Package II and V have to grant loan moratorium to customers, but they also need to comply with standard accounting practices to report impairments. But RBI has not expressly spelled out the grant of moratorium on loans by banks to NBFCs. This would have repelling effect on both earning and the lending ability of the NBFCs. There would be liquidity crunch on their part due to compliance of accounting standards and grant of moratorium simultaneously but being denied of similar moratorium for its loan.
The extension granted under Regulatory Package IV would give additional boost to NBFC sector and it would reduce the strain on their books, as the additional one-year extension shall not result in asset classification downgrade. The CRE borrowers will also get extra time for completion of projects and commercial operations that were hindered due to shutdown of activities for COVID-19 pandemic.
Ongoing resolution process
Regulatory Package III and V has overall extended the implementation of resolution plan under the Prudential Framework. It would directly affect the ongoing resolution process where the resolution plans were under consideration. Now under the relaxation norm the implementation can be affected within 390 (Three Hundred Ninety) days from the day of default from the original 210 (Two Hundred Ten) days' timeline. But it can lead to eventual deterioration in asset quality and asset classification downgrade in the second and third quarter of the financial year. Lenders with MSME and mid-size corporate exposure, would be the beneficiaries of the relaxation, as these industrial segments are the most vulnerable.
Initiation of resolution process
Regulatory Package III and V together have granted extension of 180 (One Hundred Eighty) days ("Exclusion Period"), from the date when the Implementation Period of 180 (One Hundred Eighty) days was to expire. It has excluded the Exclusion Period from the Implementation Period. This would have an effect on initiation of Review Period, consideration of resolution plans and initiation of resolution process for accounts in default post March 1, 2020. Therefore, Lenders can only initiate resolution process post Review Period under the Prudential Framework.
Provisioning by Lenders
Due to the stipulation made in Regulatory Package II, Lenders will now have to make additional provisioning of 10% (Ten) percent, spread over two quarters. While during Moratorium Period the additional provisioning will continue, they would not be able to proceed with the resolution process. This will result in additional burden on Lenders, by shaving of liquidity from their books during Moratorium Period. RBI has also allowed additional provisioning for moratorium to be adjusted against the actual provisioning requirements for slippages from the accounts reckoned for such provisions. Further, residual provisions at the end of the financial year can be written back or adjusted against the provisions required for all other accounts. It is pertinent to note that RBI has not clarified the additional provisioning stipulated under the Regulatory Package II will also extend for the additional Moratorium Period.
Disclosure and Reporting
The rescheduling of payments including interest under Regulatory Package I, II and V shall not qualify as a default for the purposes of supervisory reporting and reporting to CICs by Lenders. This was a necessary step adopted by RBI to prevent the credit history of borrowers and credit rating of the Lenders from being downgraded. Regulatory Package II required Lenders to make relevant disclosures in respect of accounts where the resolution period was extended in the 'Notes to Accounts' while preparing their financial statements for the half year ending September 30, 2020 as well as the financial years 2020 and 2021. This disclosure would probably be beneficial in tracking Stressed Assets in future.
The measures laid down by RBI will mitigate the issues faced by banking industry due to extended national lockdown. The measures were important for providing interim reliefs to borrowers in distress because of pandemic situation and help ease the burden of Lenders with respect to provisioning and delay in implementation of resolution plans. These measures would also reduce the number of litigation proceedings and disputes during the unforeseen pandemic as the reasons for default and non-compliance were beyond the control of the relevant parties.
Depending on the circumstances, many a times opting for Prudential Framework may turn out to be a better option for the Lenders, as Lenders typically have the control and authority to decide the resolution process in comparison to IBC i.e. court driven process. Further the Lender have the option to resolve the Stressed Assets under IBC and then proceed to liquidation in case of failure to resolve the Stressed Assets under the Prudential Framework, whereas, failure under IBC just provides the option of liquidation of Stressed Assets. Therefore, Prudential Framework would enable resolution of Stressed Asset with a longer timeline than IBC. In the present scenario liquidation of Stressed Assets would not provide Lenders with proper residual value, due to deterioration of value under the COVID-19 situation. Though IBC provides more power to the lenders, it is an expensive process as it involves appointment and participation of multiple intermediaries in comparison to Prudential Framework.
The Stimulus Package raised the threshold limits for initiation of insolvency under IBC, proposed to exclude COVID-19 related debt from the purview of definition of 'default' for triggering in insolvency and suspended filing of fresh insolvency proceeding up to one year, making Prudential Framework the preferred method for resolution of Stressed Assets. Therefore, many Lenders may opt for Prudential Framework for the accounts which are stressed during the suspension period of IBC.
1. (W.P.(C) URGENT 5/2020), dated 6 April 2020
2. (W.P. (C) LD-VC No. 28 of 2020
3. (W.P. (C) LD-VC No. 30 of 2020
4. Prudential Norms on Income Recognition, Asset Classification and Provisioning, pertaining to Advances, dated July 1, 2015.
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.