But, extending the moratorium ad infinitum will hide the real magnitude of stress on banks’ balance-sheets, and may even delay recapitalisation of banks, which could have made money available in the hands of businesses.
By Shardul S Shroff & Shreya Prakash
Following the onset of Covid-19 and the consequent national lockdown, businesses across India have been affected by disruptions in consumer demand, supply chain and labour availability. Keeping in view the financial stress caused by this economic disruption, the Reserve Bank of India announced a regulatory package to “mitigate the burden of debt servicing brought about by disruptions on account of Covid-19 pandemic and to ensure the continuity of viable businesses” in March 2020.
Key to this package was the ‘loan moratorium’ that lending institutions were permitted to grant in respect of term loans and working capital facilities. In essence, this moratorium permitted lending institutions to allow businesses and individuals to defer payments of loans or interests accrued on them. While allowing lending institutions to grant this moratorium to alleviate distress, RBI took various measures to ensure that the grant of this moratorium does not affect the lenders’ balance sheets, and does not trigger requirements to initiate coercive actions per extant guidelines. First, to the extent that such deferments were allowed, banks were not required to downgrade these accounts for asset classification purposes. Second, the period of the moratorium could be excluded while calculating the ‘number of days past due’ for asset classification purposes where the account was standard as on February 29, (although the Delhi and Bombay High Courts have given this a broader interpretation to include accounts already classified as SMA-1 and SMA-2). Third, the period of the moratorium could be excluded while calculating the 30-day review period under the RBI Prudential Framework on Resolution of Stressed Assets dated June 7, 2019. Finally, the 180-day resolution period under the June 7 circular was also extended in those cases where the resolution period had not expired as on March 1. Some changes to provisioning norms were also made.
The proof of the need for the moratorium is reflected in its popularity. As of April 30, itself, a mere month after the RBI permitted banks to extend this moratorium was announced, 50.1% of total outstanding of lending institutions was under the moratorium. In certain segments, for example, the MSME segment, 65% of total outstandings were under the moratorium as of April 30. Various pronouncements of courts have also ensured that both repayment moratoria and asset classification standstills were applied on-ground in a manner consistent with their intent and spirit.
While originally the moratorium and the attendant measures relating to resolution and classification were to be granted only for three months, i.e., till May 31, these were subsequently extended till August 31, i.e., for a total period of six months. This has not been extended further, and instead RBI has announced a resolution framework for Covid-19 related stress, which allows “lenders to implement a resolution plan in respect of eligible corporate exposures without change in ownership, and personal loans, while classifying such exposures as Standard, subject to specified conditions”.
Now that the moratorium has come to an end, there are some crucial implications for those who had made use of the moratorium. Most crucially, borrowers will now have to repay their loans unless they are able to restructure their loans under the Resolution Framework for Covid-19 related stress announced by RBI. Since the moratorium only deferred repayment and did not stop the accrual of interest for this period, the amount that may have to be paid is likely to have increased in total. At the same time, the asset classification standstill is also lifted, and classification downgrades may make it harder for borrowers to raise finance. Finally, the review and resolution timelines under the June 7 circular will run as they did before.
Need for extension?
While the moratorium was only intended as a temporary measure, we now see litigation pleading that the Supreme Court order the extension of the moratorium. While there cannot be an indefinite moratorium, it is crucial to examine the reasons for demanding such an extension.
First, there was an expectation that the economic disruption would be temporary, and during the moratorium, business cycles will revive on the back of government sops and a better-controlled pandemic. However, recent data shows that the disruption has led to deep distress, with the GDP contracting 23.9% in the first quarter of the year. The government relief package is unlikely to be sufficient to buoy the economy from such distress, even as Covid-19 cases in India rise. As such, businesses are not in a significantly better situation than they were at the start of the moratorium period. Secondly, there was an expectation that the moratorium period would give lenders and borrowers a breathing space to start restructuring their loans. However, that has not happened. The RBI Resolution Framework for Covid-19 related stress was only announced on August 6, and restructuring under this framework is at a very preliminary stage, especially since the financial parameters that resolution plans under this framework would have to take into account have not been decided. As such, on the lifting of the moratorium, borrowers may find themselves in a scramble to restructure accounts. Finally, there are concerns about the adequacy of the framework available to deal with distress. The RBI Resolution Framework for Covid-19 related stress has limited applicability to loan accounts that are “standard on the day of invocation” and where the lenders are clear the distress is Covid-19 related. For those accounts that do not get covered under the framework, the June 7 circular would apply, which has not proven to be very effective. Even recourse to the Insolvency and Bankruptcy Code, 2016 may not be available where default took place after March 25. Where it is available, the government has not made requisite changes to enable the resolution process to work well, even under the changed macro-economic scenario.
However, extending the moratorium ad infinitum will hide the real magnitude of stress, particularly on bank balance sheets and may even delay steps that the government needs to take to recapitalise banks and make money available in the hands of businesses.
As such, in these circumstances, it is crucial that all energies be directed towards equipping borrowers and lenders to deal with the end of the loan moratorium (even assuming it is extended by the Supreme Court). Most crucially, it is critical to ensure that effective restructuring is made available to all borrowers on-ground and that this restructuring is concluded cheaply and quickly before their stress extends further. Template resolution plans should be prepared for different types of stress scenarios, by industry associations so that the time spent in negotiating each restructuring is lower. Where restructuring through out-of-court mechanisms is not forthcoming, it is important that recourse to the Code be allowed (by not extending the suspension beyond September 25), and the Code itself be strengthened (including through the introduction of a pre-pack, amendments to section 29A and enabling going-concern sales) to ensure that it can deal with the demands of this new economy so that piecemeal enforcement doesn’t destroy value. The government may also reconsider extending further financial support, particularly through grants and tax cuts, to help alleviate stress going forward.
Shroff is executive chairman, and Prakash is associate, Shardul Amarchand Mangaldas & Co.
(The contents of the article should not be construed to provide legal advice. The views are the personal views of the authors.)