- RBI’s new circular stresses on early stress recognition
- Introduces first 30-day review period to decide on resolution
- Lenders to sign binding inter-creditor agreement to implement a resolution plan
- Failure to implement resolution within a specified time period to attract additional provision
- Very high provision on unviable cases to push them to NCLT
- Private well-capitalised banks a safe bet, most PSUs will see the struggle continuing
Ever since the Supreme Court quashed the Reserve Bank of India’s (RBI) February 12, 2018 circular pertaining to resolution of non-performing assets (NPAs), a new one from the banking regulator was eagerly awaited. While the one released on June 7 does not contain some of the provisions of February 12 Circular, such as mandatory reference of stressed account to the National Company Law Tribunal (NCLT), in essence it doesn’t change life for the banks.The February 12, 2018 Circular
It directed banks to identify incipient stress in loan accounts immediately on default by classifying stressed assets as special mention accounts (SMA) as per the following categories, SMA-0 (1 to 30 days), SMA1 (31 to 60 days) and SMA-2 (61 to 90 days). Lenders were required to report SMA to the Central Repository of Information on Large Credits (CRILC) on all borrower entities having aggregate exposure of Rs 5 crore and above on a monthly basis and all defaulting entities on a weekly basis. The June 7 circular sticks to this process.
For large accounts, post-restructuring, the residual debt required independent credit evaluation by credit rating agencies authorised by RBI. This provision has been retained in the new circular as well.
For large accounts with aggregate exposure of over Rs 2,000 crore, a reference day was set as 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 the reference day), lenders were required to file an insolvency application under the Insolvency & Bankruptcy Code (IBC) within 15 days from the expiry of the said timeline. This provision no longer exists, but that doesn’t change life for banks.The June 7 Circular
The broad contours of the new circular are early recognition of stress, complete discretion to 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.The modus operandi of the new resolution mechanism
As per 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, lenders would decide on a resolution strategy (sale of loan, legal action for debt recovery, immediate referral to NCLT etc) that could also include restructuring and change in ownership as well.
In case a RP is implemented, the lenders would sign an ICA during the review period. An agreement signed by lenders representing 75 percent of the value of outstanding, or 60 percent of lenders by number, would be binding upon all lenders. The RP would 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.
It remains to be seen how the lenders and borrowers are able to follow this procedure in a time-bound manner. Earlier the Joint Lenders Forum (JLF) had also stipulated voting thresholds to be able to implement a resolution, but it did not see much success. However, in the backdrop of a signed ICA, there is a possibility of success.Why many cases will still end up in NCLT
The critical change in the new guidelines, which makes it significantly stringent for banks and can force them to recognise and resolve stress on time, is the accelerated provision that will have to be created if the asset is not resolved in a timely manner and is not referred to NCLT.
For cases where resolution does not happen within 180 days after 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, an 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.
The accelerated provision boils down to a huge provisioning requirement. For instance, if there is no resolution of the asset within one-year from default, it will attract a provision of 50 percent -- 15 percent normal ageing provision and 35 percent additional provision. Similarly, at the end of 15 months i.e. five quarters, the total provisioning requirement jumps to 75 percent -- 40 percent normal ageing plus an additional provision of 35 percent.
Such a high provision requirement and its impact on banks' profitability will nudge them to refer cases to NCLT, if no resolution is in sight in a time-bound manner.Why referring to NCLT will make senseThe additional provision will only get reversed in the event of a complete resolution, if it is achieved outside the IBC process. 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.
Unless borrowers pay up, even under the new circular, post-default, a significant number of cases may be headed to NCLT. As far as banks are concerned, life doesn’t get any rosier. Having said that, most private banks are well past the peak of their bad asset cycle and are reorienting their businesses backed by adequate capital. For a large number of state-run lenders, while incremental formation of bad assets is on the wane, the market share loss and lack of capital makes the future uncertain and challenging.
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