RBI's proposed loan recast norms decoded; impact on banks
The Reserve Bank of India on Thursday proposed a sharp increase in the money that banks have to set aside for restructured loans.
The Reserve Bank of India on Thursday proposed a sharp increase in the money that banks have to set aside for restructured loans. If the proposal becomes law, banks will, from April 1, 2015, have to set aside 5 percent of the loan value as provision towards that loan going bad, instead of the 2.75 percent they are setting aside at present. Also, all restructured loans, except those to infra projects, will have to be treated as non-performing assets from April 1, 2015, if the draft guidelines are accepted. It is proposed that provisioning for existing restructured loans should be increased in a phased manner to 3.75 by end of 2013-14, and to 5 percent by 2014-15.
Here is what you need to know about the RBI proposals:
1. What is a restructured loan?
A: When a borrower finds it difficult to repay a loan, the lender may have to choose between either getting back nothing at all, or settling for an amount lower than what had been loaned. In such cases, the terms of the loan are restructured. It could be an extension in the tenure of the loan or a reduction in the interest rate, or both.
2. What is provisioning for loans?
A: Banks have to set aside a certain amount towards a loan, if there are indications that the borrower may not be able to repay it on time, or may not be able to pay back at all.
3. What are the current rules for restructured loans?
A. Banks have to make a provision of 2.75 percent for restructured loans. Also, banks can treat the restructured loan as standard assets. RBI had relaxed the rules in the aftermath of the 2008 global financial crisis, to avoid large scale defaults by corporates. Banks would not have had enough money for provisions if there were too many defaults.
4. Why are banks worried about provisioning?
A. Because they have to provide for it from their quarterly profits. Higher the provisions, lower the profits. That is why banks try hard to avoid classifying a loan as a sub-standard asset for as long as possible. Corporate borrowers also try to avoid being labeled as defaulters, by making some token interest payments. At times banks issue fresh loans to troubled borrowers, who then use the funds to repay their old loans and escape being classified as defaulters.
5. Why has the RBI proposed tighter rules for restructured loans?
A. There were allegations that many promoters were willfully defaulting on loans, citing the excuse of economic slowdown, and getting favourable terms on the restructured loans. Often, banks too played ball, because they could still classify the loans as standard assets while making a provision of 2.75 percent. Some analysts claim the provisions being made by banks do not fully reflect the extend of bad loans in their portfolio.
6. What are standard assets, sub-standard assets and doubtful assets?
A: Standard assets are those loans where interest payments are being made on time. Sub-standard assets are those where no interest payments have been made for 12 months and doubtful assets are those where no interest payments have been made for more than 12 months.
7. What are the provisions banks have to make for sub-standard and doubtful assets?
A. Banks have to set aside 15-25 percent for sub-standard assets, based on whether or the loans are secured or unsecured. Banks have to provide 100 percent towards doubtful assets.