Financial Parameters For The Covid-19 Resolution Framework || One Size 'Does Not' Fit All
On August 6, 2020, the Reserve Bank of India (RBI) took a significant step towards scaling the exponential onset of financial stress induced by the COVID-19 pandemic and put forth a series of regulatory measures through its Circular bearing no. RBI/2020-21/16 DOR. No. BP. BC/3/21.04.048/2020-21 titled 'Resolution Framework for COVID-19 related Stress'. The 'August 6th Circular', as is being colloquially referred since, laid down certain directives that are aimed at providing an interim regulatory forbearance to credit-exposures facing financial stress singularly & directly attributable to the pandemic; whilst, mandating requisite credit discipline amongst the Banks & Financial Institutions (FIs) so as to ward-off the 'delinquent' accounts from piggy-backing the Resolution Framework.
On lines of this over-arching principle and towards ensuring the clinical identification & assessment of eligible Credit exposures, the 'August 6th Circular' had explicitly advised the Banks & FIs to put in place their Board-approved policies covering the Eligibility criteria & Due diligence standards. Furthermore, being cognizant of the past instances wherein some Regulatory policies have been quoted as falling short of their anticipated outcomes, the RBI has, this time around, wrested requisite control to objectively see through the execution of the Resolution Framework - with the 'means' being given due & equal importance as the 'ends'. The requirement, under the 'August 6th Circular', to constitute an 'Expert Committee' and vest it with independent responsibilities was a considered move by RBI in that direction.
The Requirement,
In a welcome & timely departure from the generic principle of 'One-size-fits-all', the RBI had, by virtue of the 'August 6th Circular', required constitution of an 'Expert Committee' and bestowed it with the onus of:
- identifying the key 'Financial parameters' which would be considered by the Banks & FIs whilst structuring the Resolution Plans under the Prudential Framework for their respective COVID-19 related stressed exposures; and
- recommending 'sectoral benchmarks' of such identified Financial parameters; and
- proposing 'other financial or non-financial conditions' which may be considered for the Resolution Plan within the broader contours of the framework.
Quite significantly, the Expert Committee has been tasked with the responsibility of review of the Resolution Plans, under the 'August 6th Circular' of all such accounts wherein the aggregate Credit exposure is INR 1500 crore or more. Though the Expert Committee has to stop itself short of assessing the commercial merits of the Resolution Plan submitted to it for its review; yet, it has been mandated to validate that the requisite & prescribed processes under the 'August 6th Circular' have been duly followed whilst structuring the Resolution Plans.
the Committee,
Given the pressing need of the Financial parameters and Sectoral benchmarks for ensuring effective implementation of the Resolution Framework proposed under the 'August 6th Circular', the RBI swiftly moved to put together a 5-member Expert Committee under the Chairmanship of Shri. K. V. Kamath[1], who besides being one of the most prolific & seasoned bankers in the Country, is widely acclaimed to be an institution-builder par excellence in his own right.
As time was of the essence, the 'August 6th Circular' required the KV Kamath Committee to submit its recommendations on the Financial Parameters and the Sector-specific benchmarks within a strict time-frame so as to enable RBI to assess and notify the same within 30 days of the Circular. Additionally, given the functional role of the KV Kamath Committee in vetting of the Resolution Plans structured under the 'August 6th Circular', the tenure of the KV Kamath Committee was made coterminous with the maximum timeline prescribed for implementation of the Resolution Plan i.e. June 30, 2021.
the Recommendations, and
The KV Kamath Committee, as envisaged, kept to the prescribed timelines and, on September 4, 2020, submitted to RBI a thorough and reasoned set of recommendations comprising, inter alia, its suggestions of the Financial parameters and Sectoral benchmarks for the Resolution Plans to be structured under the 'August 6th Circular'[2]. Some key facets of the KV Kamath Committee's recommendations are summarized as below:
- The KV Kamath Committee, after detailed internal deliberations & due consultation with multiple stakeholders in the Industry coupled with a comparative study of financials of companies across various sectors[3], drew up an Industry matrix reflecting the Sectors which had been at the receiving end of the financial stress induced by the ensuing pandemic. On a cursory glance of the matrix, based on the banking sector debt, one is able to decipher that there happen to be sectors which
- were under stress even prior to the COVID-19 impact (like NBFCs, Power, Steel, Real Estate, Construction, Automobiles etc) and the pandemic has severely compounded their problems; besides,
- the long list of new entrants which have been grounded by the impact though being decent performers prior to the pandemic like Retail & Wholesale trade, Roads, Textiles & Engineering, Petroleum & Chemicals, Tourism & Hospitality, Paper, Mining, Media & Entertainment.
There, however, happen to be some sectors (Agriculture, Pharma, Food processing, FMCG, Dairy etc) which seem to have developed a decent immunity from the consequent financial stress of COVID-19.
- While acknowledging the pervasive effect of the ensuing pandemic which has affected even the best of the companies, the KV Kamath Committee recognized that on account of multiple compliances (legal, financial, & regulatory)[4] the restructurings have, historically, been a time-consuming exercise; a trait which is better kept under 'watch' given the extant financial stress in the Country and the Resolution Framework prescribed under the 'August 6th Circular'. Hence, the Committee suggested that 'considering the large volume and the fact that only Standard assets are eligible under the proposed scheme, a segmented approach of bucketing these accounts under mild, moderate and severe stress, may ensure quick turnaround.'
Moving to the vital part of identification of Financial Parameters, the KV Kamath Committee recommended a set of 5-financial parameters which would assume relevance and consideration whilst formulating the Resolution Plan under the 'August 6th Circular'[5]:
- Total Outside Liability / Adjusted Tangible Net Worth (TOL / Adjusted TNW)
- Total Debt / EBIDTA
- Current Ratio
- Debt Service Coverage Ratio (DSCR), and
- Average Debt Service Coverage Ratio (ADSCR)
The Committee was of the view that the Sectoral benchmarking on the basis of the aforementioned financial ratios/parameters would enable a more cohesive and clinical assessment of the Credit Exposures which would be under consideration by the Banks/FIs for the prescribed regulatory forbearance under the 'August 6th Circular'.
The KV Kamath Committee moved on to the daunting (and oft critically assessed) prescription of Sectoral benchmarks – which may be seen as an imitable departure from the antiquated (yet, rampantly adopted) doctrine of 'One-size-fits-all'. Regardless of the episodic scarcity of time, the Committee's recommendations have identified 26 sectors of the Indian economy and recommended corresponding benchmarks/financial ratios respective, which itself bears witness to an obvious 'fact' & its consequent 'requirement' – the former, being the widespread financial stress induced by the pandemic, followed by the immediate necessity of surgical regulatory measures. The clarity of intent and application whilst proposing Sectoral benchmarks for the Resolution is not only reflective in the KV Kamath Committee's statement in the Report submitted to RBI (reproduced below), but also is evident from the fact that Financial ratios have been diligently researched and its inapplicability reasoned on coherent grounds[6] -
"The sector specific parameters may be considered as guidance for preparation of RP for a borrower in the specified sector. The RP may be prepared based on the pre-Covid-19 operating and financial performance of the borrower and impact of Covid-19 on its operating and financial performance in Q1 and Q2FY21, to assess the cash-flows for FY21 / FY22 and subsequent years."
the Acceptance.
On September 7, 2020, the RBI, vide Circular bearing no. RBI/2020-21/34 DOR. No. BP. BC /13/21.04.048/2020-21 titled 'Resolution Framework for COVID-19 related Stress – Financial Parameters', accorded its broad acceptance to the recommendations of the KV Kamath Committee's 'Report of the Expert Committee on Resolution Framework for COVID-19 related Stress'. Whilst adopting the Financial parameters recommended by the KV Kamath Committee on an 'as-is-where-is', RBI has mandated a compulsory requisition from Banks & FIs to factor-in the 5-Financial parameters[7] whilst formulating Resolution Plans under the 'August 6th Circular' in respect of Credit exposures to Corporate entities[8].
In addition, the RBI has summarized and given a regulatory mandate to the following facets of the KV Kamath Committee's report:
- The Sectoral benchmarks[9] for each of the Financial parameters is required to be considered by the 'lending institutions' in the resolution assumptions with respect to an eligible borrower. For sectors which do not find mention, the Banks/FIs have been encouraged to make their own assessments on the prescribed Financial parameters[10] in terms of the Circular of September 7, 2020;
- The RBI has clarified that the prescribed Financial parameters should not be taken as exhaustive and the Banks/FIs have absolute independence to consider additional financial criteria/ratios 'while finalizing the resolution assumptions in respect of eligible borrowers apart from the above mandatory key ratios and the sector-specific thresholds that have been prescribed';
- Besides due consideration to the prescribed Sectoral benchmarks, the importance of the comparative assessment of pre-Covid-19 operating and financial performance of a Credit exposure and the impact thereon resulting post-Covid-19 is required in course of formulating the Resolution plan, in order to assess the cashflows in subsequent years, while stipulating appropriate ratios in each case;
- The RBI has, in due recognition of differential impact of the COVID-19 induced financial stress across multiple sectors, recommended the Banks/FIs to adopt a graded-approach depending on the severity of the impact which may also include classification into mild, moderate and severe, as recommended by the KV Kamath Committee;
- On the specific aspect of actual implementation of the Resolution Plan under the aegis of the 'August 6th Circular', RBI has required due compliance to TOL/ATNW agreed in the Resolution Plan and maintenance of the same by March 31, 2022 and on an ongoing basis thereafter. Also, in scenarios where the Resolution Plan envisages equity infusion, the RBI has recommended that the same to be suitably phased-in over the period ending March 31, 2022. The Sectoral Benchmarks shall have, irrespective, to be maintained as per the Resolution Plan by March 31, 2022 and on an ongoing basis thereafter;
- In order to override the time-intensive exercise of execution of the Inter-Creditor Agreement (ICA), the RBI has, yet again, categorically made the signing of ICA a mandatory requirement on part of the Banks/FIs. In fact and quite rightly so, RBI has gone the extra-mile to clarify that the additional provisioning requirements on failure to execute the ICA under the 'August 6th Circular' should not be construed by the Banks/FIs as a 'safety-valve' to wreak avoidable chaos to the coordinated approach prescribed under the ICA for implementation of the Resolution Plan.
- Besides, of course, to have a crystal visibility and control over the cash-flows of the Credit exposures reaping benefits of the regulatory forbearance under the 'August 6th Circular', the RBI has reiterated the maintenance of an escrow account after implementation of a Resolution Plan.
Quite evidently, the 'August 6th Circular' being punctually supported by the KV Kamath Committee's recommendations and RBI's assent thereto, may be considered as a refraction point for the Regulatory regime in the Country which is diligently poised and committed to tide over these unprecedented times of pandemic.
Appendix I
| Financial Parameters | Definitions |
| | TOL / Adjusted TNW
| Addition of long-term debt, short term debt, current liabilities and provisions along with deferred tax liability divided by tangible net worth net of the investments and loans in the group and outside entities.
|
| | Total Debt / EBIDTA | Addition of short term and long-term debt divided by addition of profit before tax, interest and finance charges along with depreciation and amortisation.
|
| | Current Ratio | Current assets divided by current liabilities.
|
| | Debt Service Coverage Ratio (DSCR) | For the relevant year addition of net cash accruals along with interest and finance charges divided by addition of current portion of long term debt with interest and finance charges.
|
| | Average Debt Service Coverage Ratio (ADSCR) | Over the period of the loan addition of net cash accruals along with interest and finance charges divided by addition of current portion of long term debt with interest and finance charges. |
Appendix – II
| Sectors | TOL / ATNW | Total Debt/ EBITDA | Current Ratio | Average DSCR | DSCR |
| ||||
| Auto Components | <= 4.50 | <= 4.50 | >= 1.00 | >= 1.20 | >= 1.00 |
| ||||
| Auto Dealership | <=4.00 | <=5.00 | >=1.00 | >=1.20 | >=1.00 |
| ||||
| Automobile Manufacturing | <= 4.00 | <= 4.00 | NA | >= 1.20 | >= 1.00 |
| ||||
| Aviation | <= 6.00 | <= 5.50 | >= 0.40 | NA | NA |
| ||||
| Building Materials - Tiles | <=4.00 | <=4.00 | >=1.00 | >=1.20 | >=1.00 |
| ||||
| Cement | <=3.00 | <=4.00 | >=1.00 | >=1.20 | >=1.00 |
| ||||
| Chemicals | <=3.00 | <=4.00 | >=1.00 | >=1.20 | >=1.00 |
| ||||
| Construction | <=4.00 | <=4.75 | >=1.00 | >=1.20 | >=1.00 |
| ||||
| Consumer Durables / FMCG | <=3.00 | <=4.00 | >=1.00 | >=1.20 | >=1.00 |
| ||||
| Corporate Retails Outlets | <=4.50 | <=5.00 | >=1.00 | >=1.20 | >=1.00 |
| ||||
| Gems & Jewellery | <=3.50 | <=5.00 | >=1.00 | >=1.20 | >=1.00 |
| ||||
| Hotel, Restaurants, Tourism | <=4.00 | <=5.00 | >= 1.00 | >=1.20 | >=1.00 |
| ||||
| Iron & Steel Manufacturing | <=3.00 | <=5.30 | >=1.00 | >=1.20 | >=1.00 |
| ||||
| Logistics | <=3.00 | <=5.00 | >=1.00 | >=1.20 | >=1.00 |
| ||||
| Mining | <=3.00 | <=4.50 | >=1.00 | >=1.20 | >=1.00 |
| ||||
| Non-Ferrous Metals | <=3.00 | <=4.50 | >=1.00 | >=1.20 | >=1.00 |
| ||||
| Pharmaceuticals Manufacturing | <=3.50 | <=4.00 | >=1.00 | >=1.20 | >=1.00 |
| ||||
| Plastic Products Manufacturing | <=3.00 | <=4.00 | >=1.00 | >=1.20 | >=1.00 |
| ||||
| Port & Port Services | <=3.00 | <=5.00 | >=1.00 | >=1.20 | >=1.00 |
| ||||
| Power |
| |||||||||
| - Generation | <=4.00 | <=6.00 | >=1.00 | >=1.20 | >=1.00 |
| ||||
| - Transmission | <=4.00 | <=6.00 | >=1.00 | >=1.20 | >=1.00 |
| ||||
| - Distribution | <=3.00 | <=6.00 | >=1.00 | >=1.20 | >=1.00 |
| ||||
| Real Estate |
| |||||||||
| - Residential | <=7.00 | <=9.00 | >=1.00 | >=1.20 | >=1.00 |
| ||||
| - Commercial | <=10.00 | <=12.00 | >=1.00 | >=1.20 | >=1.00 |
| ||||
| Roads | NA | NA | NA | >=1.10 | >=1.00 |
| ||||
| Shipping | <=3.00 | <=5.50 | >=1.00 | >=1.20 | >=1.00 |
| ||||
| Sugar | <=3.75 | <=4.50 | >=1.00 | >=1.20 | >=1.00 |
| ||||
| Textiles | <=3.50 | <=5.50 | >=1.00 | >=1.20 | >=1.00 |
| ||||
| Trading – Wholesale | <=4.00 | <=6.00 | >=1.00 | Instead Interest Coverage | ||||||
Anand Srivastava is Partner & Aditya Bhardwaj is an Associate Partner at Link Legal India Law Services. Views are personal .
[1] KV Kamath Committee: (1) Shri. KV Kamath, Chairperson; (2) Shri Diwakar Gupta, Member; (3) Shri. TN Manoharan, Member; (4) Shri. Ashvin Parekh, Member; and (5) Shri. Sunil Mehta, Member Secretary.
[2] 'Report of the Expert Committee on Resolution Framework for COVID-19 related Stress'
[3] CRISIL, ICRA CARE, Association of Power Producers, National Highways Builders Federation (NHBF) and CREDAI National etc. The Committee also studied the RBI's Financial Stability Report and other Publications and Research Reports. It also studied comparison of Q1 FY 2021 with Q1FY 2020 financials of companies across many sectors.
[4] Execution of ICA, Forensic Audit, Valuation process, Techno-Economic viability report, Rating criteria, Stock & Receivables audit, Legal documentation & creation of security interests etc
[5] Appendix I
[6] Roads: In the roads sector, the financing is cash flow based and at SPV level where the level of debt is decided at the time of initial project appraisal. It may also be noted that the working capital cycle in this sector is negative. Accordingly, ratios like TOL / ATNW, Debt/EBITDA and Current ratio may not be relevant at the time of restructuring in this sector. Since cash flows of several projects are by way of annuity payments, the threshold ADSCR has been kept at 1.10.
Airports: 1. Targeted Current Ratio for Airline Industry is kept at 0.40 and above because of following key reasons: (a) Cash and carry model for revenue purpose, thereby creating almost nil debtors and higher current liabilities in form of advance received from customers. These advances are approximately 2 months of yearly sales of the airline industries. (b) The airline enjoys credit of typically 6-9 months from vendors (including fuel payment).
2. DSCR is not ascertainable for airline industry since most of the airline companies work on refinancing of debt as a financing strategy. As a consequence, Avg. DSCR is not ascertainable for airline industry.
Automobiles: We are not prescribing any threshold for Current Ratio due to the "just in time inventory" business model for raw materials and parts, and finished goods inventory is funded by channel financing available from the dealers.
Trading Wholesale: DSCR/ Avg. DSCR is not ascertainable for trading business as most of the companies do not use long term debt for funding their operations and are unlisted.
[7] Appendix I
[8] Eligible borrowers under Part B of the Annex to the RBI Circular bearing no. RBI/2020-21/16 DOR. No. BP. BC/3/21.04.048/2020-21 titled 'Resolution Framework for COVID-19 related Stress' dated August 6, 2020.
[9] Appendix II
[10] Internal assessments regarding TOL/ATNW and Total Debt/EBITDA. The current ratio and DSCR in all cases shall be 1.0 and above, and ADSCR shall be 1.2 and above.