Looking into Loan Restructuring
The impact of the pandemic-led nationwide lockdown on economic activity, especially in the lending sector has been immense. Everyone from small town lenders to multinational banks have been affected. As job losses and pay cuts started as early as March, the Reserve Bank of India announced a moratorium on loan repayments.
In its financial-stability report, published on 24 July, the RBI noted that half of all loans stood unpaid in April. That is why the moratorium was extended for three more months till August. Going further, the borrowers were also credited with a reversal of ‘interest over interest’ levied on those who availed of the moratorium.
Union finance minister Nirmala Sitharamanmet with commercial banks and shadow lenders to discuss the restructuring of loans and find ways to ease the sufferings from the lockdown. Ever since, banks have been in discussion to find ways to restructure the loans better after the lockdown. A five-member expert committee headed by former ICICI Chairman KV Kamath provided recommendations on the methods and parameters required for what is to be the banking sector’s biggest ever loan restructuring programme.
According to a RBI circular released after the aforementioned meeting, not all loans are eligible to be restructured. Loans that were classified as standard, but not in default for more than 30 days, as well as retail loans (home, top-up loan, car, personal, education, gold) can be restructured. Borrowers will have to provide documentary evidence that they have been financially affected by a reduction in salary due to the lockdown. They will also have to apply for loan restructuring before December 31st, 2020.
As for the banks, the RBI recommended that the following be taken carefully into consideration when taking a decision on restructuring:
- Total outside liabilities /adjusted tangible net worth
- Total debt/Ebitda Current ratio
- Current Ratio
- Debt service coverage ratio
- Average debt service coverage ratio
But will this work?
According to KV Kamath, the head of the committee that drafted the recommendations, the plan is fool proof. Kamath says that the tight regulations and the timeframe makes it very hard to misuse the restructuring policy. It is in everybody’s interest: the borrowers get extra time to pay off their debts, while the banks can earn more and get back on their feet.
Considering how easy it is to misuse the policies, and the possibilities of the plan failing, banks, bankers, and experts are all apprehensive about the restructuring plan. “In the past, loan restructuring plans failed because it took an endless amount of time. By the time it was put into action, the scenario had changed, and you were still midway through the process,” said Kamath. “…which is why it was doomed for failure. This time around, the timeline is virtually less than a year to see the process through. To my mind it is as tight as it gets.”
The important thing to note is that this will be a one-time loan restructuring. Banks can offer an extra moratorium of up to two years or extend the tenure of a loan and reduce the EMI according to the borrower’s payment abilities. There is, therefore, a timeline and a set of defined terms and conditions.
However, all this planning and policy making depends on the economy’s recovery. If the nation’s GDP continues to drop the way it is currently, even restructured loans face the risk of becoming bad debts and become NPAs. Bigger banks like ICICI and State Bank of India may yet be able to survive the storm.
The danger is therefore for smaller lenders and cash-strapped smaller banks to prevent loans from becoming NPAs. Faced with pre-existing legacy problems and uncertain loans, these smaller banks that cater to micro, small, and medium enterprises (MSMEs) are at great risk. It is now apt to focus on nourishing and reviving the MSMEs, the backbone of the Indian economy.