RBI has recognised the need for the participation of lenders that are not regulated by the RBI in the collective resolution process.
L Viswanathan and Gaurav Gupte
The RBI had previously announced a regulatory package to help borrowers mitigate the burden of debt servicing brought about by disruptions on account of the COVID 19 pandemic, maintain continuity of viable businesses and to stabilise financial markets. These measures, particularly the moratorium on loan repayment and the standstill on asset classification, were intended to deal with the immediate crisis. However, as the end of the moratorium period approaches, it was apparent that more permanent measures would be required to address the financial conditions caused by the pandemic. These permanent measures have been announced by the RBI by way of the “Resolution Framework for Covid Related Stress”.
A two-year moratorium, sectoral approach in resolution benchmarks, continuation of existing management, focus on the real sector and exclusion of financial service providers are key highlights of this framework. The special framework makes a number of variations to the general resolution framework prescribed under the June 7, 2019 directions of the RBI to facilitate resolution of assets that are stressed only on account of the pandemic. The framework is a balance between the imperative of addressing the immediate distress and longer-term safeguards.
While the framework deals with personal loans and corporate exposures, in this article we look at the latter.
In its most significant feature, the framework enables lenders to implement a resolution plan without a change in ownership while classifying such exposures as ‘standard assets’, subject to specified conditions. In the absence of this dispensation, any restructuring would result in a standard asset being downgraded to a ‘non-performing asset” (NPA) (with prescribed provisions to be maintained) until the restructured asset demonstrates ‘satisfactory performance’, or there is a change of control of the borrower. Such change of control could be an unfair penalty for promoters of borrowers already suffering from the effect of the pandemic. Further, implementing a change of control takes more time as lenders typically need to run a process to identify new owners. In this background, the new framework is a relief to both borrowers and lenders.
The framework provides flexibility in the manner of restructuring, including rescheduling of payments, conversion of any interest accrued, or to be accrued, into another credit facility, or granting of moratorium, subject to a maximum of two years. To prevent misuse, the framework takes a calibrated approach.
- First, the relief is limited only to COVID affected borrowers – only if loans of the borrower were ‘standard’ as on March 1, 2020 (and not in default for more than 30 days on that date), is it eligible under the framework. This condition is narrower than the asset classification standstill that the RBI had previously allowed (which applied even if the asset was SMA2 on February 29, 2020), and shows the RBI’s intent to provide relied to otherwise viable businesses distressed solely on account of the pandemic. This will prevent moral hazard issues.
- Second, the framework incentivises a time-bound approach by providing a limited window during which the resolution process can be invoked. The process is required to be invoked by December 31, 2020 and must be implemented within 90 days of invocation.
- Third, the resolution process can be considered to be invoked only if the borrower agrees to proceed with a resolution under this framework. This will prevent recalcitrant borrowers from subsequently obstructing the implementation of agreed resolution plans.
- Fourth, the RBI has constituted an expert committee chaired by Mr. K.V. Kamath, an industry veteran, to recommend the financial parameters, with sector-specific benchmark ranges, that may be factored into the assumptions that go into each resolution plan. This will help demarcate the necessary boundary conditions to avail of the restructuring and permit a nuanced approach for providing relief to sectors that are affected by the pandemic. The expert committee will also vet the resolution plans for larger corporate exposures to be implemented under this framework, including verification of compliance with all processes, while retaining the commercial judgment of lenders.
Finally, the RBI continues to incentivise collective action by lenders, by requiring additional provisioning for lenders who do not sign the inter creditor agreement. This requirement is necessary to maintain the sanctity of any collective process and should be made applicable for resolution processes outside this special window also.
Further, the RBI has recognised need for the participation by lenders that are not regulated by the RBI in the collective resolution process and it is hoped that other sectoral regulators also provide an enabling framework for resolution by entities that they regulate. We believe that the new Resolution Framework for Covid Related Stress will give the necessary relief required to rebuild the real sector in view of the COVID distress and is welcome for its calibrated and thoughtful approach.
L Viswanathan and Gaurav Gupte are partners at Cyril Amarchand Mangaldas. Views expressed are the authors’ personal.