Explainer | RBI’s new June 7 circular on NPA resolution

RBI Governor Shaktikanta Das

After the Supreme Court quashed RBI’s February 12, 2018, circular, a new one on NPA resolution was awaited. On June 7, 2019, the RBI came out with a new circular. Moneycontrol Research tries to decode the same to ascertain its key features and tries to assess if life is going to be any different for banks under the new framework.

What are the key contours of the new NPA circular issued by RBI on June 7?

The broad contours of the new circular are early recognition of stress, complete discretion of lenders to decide on a resolution plan, but no revival of the earlier failed schemes like SDR, S4A etc., signing of a binding inter-creditor agreement (ICA) to finalise and implement the resolution plan and an accelerated provision if the time-bound resolution fails. It’s not mandatory for banks to refer cases to IBC (Insolvency and Bankruptcy Code). (Read more on IBC)

What were the highlights of the earlier February 12, 2018, NPA resolution circular of RBI?

It directed banks to identify incipient stress in loan accounts immediately on default, by classifying stressed assets as special mention accounts (SMA).

It encouraged lenders to go in for resolution. However, the conditions attached with the resolution plan (RP) were onerous.

Read: New NPA circular from RBI – a significant number of cases may be headed to NCLT

For large accounts with aggregate exposure of over Rs 2,000 crore, a reference day was set on March 1, 2018. If a resolution was not implemented within 180 days of the reference day or default day (if default day was later than reference day), lenders were required to file insolvency application under IBC within 15 days from the expiry of the said timeline.

What is the exact modus operandi of NPA recognition and resolution under the new circular?

According to the new guidelines, in the event of a borrower defaulting to any lender, all lenders to the borrower would put in place a resolution plan (RP) within 30 days of such default. During this 30-day Review Period, the lenders would decide on a resolution strategy (sale of loan, legal action for debt recovery, immediate referral to NCLT etc.) which could also include restructuring and change in ownership as well.

In case an RP is implemented, the lenders would sign Inter Creditor Agreement (ICA) during the Review Period. An agreement signed by lenders representing 75 per cent by value of outstanding or 60 percent of lenders by number would be binding on all lenders. The RP shall provide for payment not less than liquidation value (estimated realisable value of the assets) due to the lenders. For most large borrowers, the resolution plan will have to be implemented within 180 days from the end of the Review Period.

What provision of this circular makes it look more effective prima facie?

One key feature of the new circular is the binding Inter Creditor Agreement to achieve resolution in a time-bound manner. It remains to be seen how the lenders and borrowers are able to follow this. Earlier, the Joint Lenders Forum (JLF) had also stipulated voting thresholds to be able to implement a resolution. The same did not see much success. However, in the backdrop of a signed ICA, there is a possibility of few successes.

What are the penalties if the resolution is not achieved as per the intended timeline?

For cases where resolution does not happen within 180 days post the review period, an additional provision of 20 percent will have to be made.

If the resolution does not take place within 365 days from the commencement of the Review Period, a further additional provision of 15 percent (hence, total additional provision becomes 35 percent) will have to be made.

These provisions will be over and above the ageing provisions that banks provide once the asset turns non-performing.

Why banks may still refer a lot of cases to NCLT?

The accelerated provision boils down to mindboggling provisioning requirement that are worth taking note of. For instance, if there is no resolution of the asset, within one year from default, it will attract provision of 50 percent – 15 percent normal ageing provision and 35 percent additional provisions. Similarly, at the end of 15 months i.e. five quarters, the total provisioning requirement jumps to 75 percent – 40 percent normal ageing plus 35 percent additional provisions.

Such high provision requirement and its impact on profitability of banks will nudge them to refer cases to NCLT (National Company Law Tribunal), if no resolution is in sight in a time-bound manner.

In case the resolution is pursued under IBC, half of the provision would get reversed on filing of insolvency application and the remaining half on admission of the borrower into the insolvency resolution process under IBC.