Loan Moratorium Exceeding 6 Months Will Impact Borrowers' Credit Behaviour: RBI Tells SC, Also Urges To Lift The Stay On NPA Classification
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In response to a large number of Writ Petitions making diverse prayers relating to its Circular on Covid-19 - Regulatory Package dated March 27, 2020, and subsequent circulars issued on the matter; and the Circular on Resolution Framework for Covid19-related Stress dated August 6, 2020, the RBI has filed a consolidated reply before the Supreme Court."Reserve Bank of India has taken a...
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In response to a large number of Writ Petitions making diverse prayers relating to its Circular on Covid-19 - Regulatory Package dated March 27, 2020, and subsequent circulars issued on the matter; and the Circular on Resolution Framework for Covid19-related Stress dated August 6, 2020, the RBI has filed a consolidated reply before the Supreme Court.
"Reserve Bank of India has taken a balanced view, taking into account the interest of the depositors, borrowers, real sector entities and banks. Financial stability and economic growth of the country were also kept in mind while arriving at its policy decisions by the Reserve Bank. All the issues that were advanced by the petitioners have been adequately addressed. There is no scope for further grievance for the petitioners", it is asserted, addressing the concerns raised as follows:
I. MEASURES TAKEN BY THE RESERVE BANK TO ADDRESS THE ECONOMIC FALLOUT OF COVID19 AND THEIR IMPACT
It is submitted that the RBI is cognizant of the enormity of the challenges faced in the wake of Covid19 and accordingly has already announced several measures to mitigate the immediate impact on the real sector as well as financial sector.
These comprehensive measures can be classified as under:
1. Reduction in Policy Rates
2. Maintaining adequate liquidity in the system for all the constituents;
3. Easing Financial Stress for the borrowers;
4. Facilitating and incentivising bank credit flows;
5. Supporting Exports and Imports;
II. GUIDELINES PERMITTING MORATORIUM ON DEBT REPAYMENTS
One of the first set of measures announced by the Reserve Bank was on March 27, 2020 to alleviate the immediate financial stress on the borrowers in continuing to make repayments on their borrowings. The aforesaid circular dated March 27, 2020 was further modified vide circulars dated April 17, 2020 titled COVID19 Regulatory Package - Asset Classification and Provisioning and May 23, 2020 titled "Covid-19 Regulatory Package" whereby the moratorium period was extended by another three months i.e. from June 1, 2020 to August 31, 2020 on payment of all instalments in respect of term loans (including agricultural term loans, retail and crop loans). Thus, in terms of the above guidelines, a total of six months of moratorium was permitted, which expired on August 31, 2020.
Waiver of interest/interest on interest during the moratorium period
It is submitted that any waiver of interest on interest, or compounding as it is referred to in financial parlance, will entail significant economic costs which cannot be absorbed by the banks without serious dent of their financials, which in turn will have huge implications for the depositors and the broader financial stability. It is pointed that Union of India vide its affidavit dated October 2, 2020 has submitted before the Court the decision of the Government to bear the cost of the 'interest on interest' for MSME loans and personal loans upto Rs. 2 crore. This decision by the Government to provide additional relief to a large segment of borrowers has addressed the primary prayers of the petitioners.
Guidelines being discretionary and not mandatory
The other major issue raised by various petitioners against the moratorium circulars being that these are not automatically available to all borrows but contingent on the discretion of the lenders, it is submitted that the Reserve Bank has only provided an enabling mechanism for the lenders to permit the moratorium, without the same being treated as restructuring of the terms of the loan contract for regulatory purposes. However, since the customer profile and business model of each lending institution is widely different from others, each lending institution is best placed to assess the requirements of its customers. Therefore, the discretion regarding deciding the eligibility of customers and manner in which the customers are on-boarded for availing this benefit was left to the lending institutions concerned. "Providing the discretion to respective institutions in extension of the moratorium/deferment cannot be termed as discrimination or classification", it is argued.
Extension of moratorium
Various petitioners have made a prayer for extension of the moratorium beyond August 31, 2020. In this regard, it is submitted that the moratorium was permitted as a part of immediate regulatory response, aimed at providing temporary reprieve to borrowers affected by the pandemic, while attempting to preserve the resilience of the financial system. It entails significant costs to the lenders and a balance needs to be maintained in the overall consideration. A long moratorium exceeding six months can also impact credit behaviour of borrowers and increase the risks of delinquencies post resumption of scheduled payments.
III. RESOLUTION FRAMEWORK FOR COVID19- RELATED STRESS
The Resolution Framework issued by the Reserve Bank on August 6, 2020 is aimed at facilitating revival of real sector activities and mitigating the impact on the ultimate borrowers, which are under financial stress caused by economic fallout on account of Covid-19 pandemic. In terms of the Resolution Framework, only those borrower accounts shall be eligible for resolution which were classified as standard, but not in default for more than 30 days with any lending institution as on March
1, 2020. The resolution plans implemented under framework may inter alia include rescheduling of payments, conversion of any interest accrued, or to be accrued, into another credit facility, or, granting of moratorium, based on an assessment of income streams of the borrower for two years. The reliefs for each borrower can be tailored by banks to meet the specific problem being faced by each borrower depending on need rather than have a broad- brush approach in dealing with the issue.
Eligibility Conditions
The petitioners have contended that accounts which were standard but overdue beyond 30 days as on March 1, 2020 have also been impacted on account of Covid19 and therefore need to be considered as eligible under the Resolution Framework.
"However, this is a classic fallacy of composition which presumes that the accounts paying on time can be equated with accounts paying with a considerable delay. An account which was impacted by pandemic as well as had a pre-existing financial has a different risk profile as compared to an account without pre-existing stress and to treat both borrowers on equal footing would be gross suspension of economic sensibilities", it is urged.
Sector-specific Issues
Many petitioners have prayed for directions to RBI to announce sector-specific reliefs instead of a monolithic Resolution Framework. Such prayers deliberately obfuscate the fact that Resolution Framework gives complete discretion to lending institutions and borrowers to arrive at resolution plans which are tailored to the specific requirements of sector subject to the prudential boundaries specified therein.
"Such sector-specific differentiation was also recognised in the terms of reference of the Expert Committee. The Expert Committee has recommended sector specific thresholds to the mandatory financial parameters, which are more liberal than normal lending financial benchmarks, that need to be considered in the financial projections while designing the resolution plans", it is argued.
It is stated that the circular of September 7, 2020 provides for separate thresholds for 26 sectors including power, real estate and construction. Even under power sector, separate thresholds have been prescribed for generation, transmission and distributions sectors. Similarly, separate thresholds have been prescribed for residential and commercial real estate sectors. In respect of those sectors where the sector-specific thresholds have not been specified, lending institutions have been permitted to make their own internal assessments.
It is asserted that sufficient discretion has been given to the lending institutions subject to the prudential boundaries specified in the Resolution Framework to design resolution plans factoring in sector specific requirements because they are best placed to understand the specific requirements of their counterparties as they would already have undertaken sector specific due diligence during credit appraisal. Resolution plans are ultimately commercial decisions of the lending institutions which cannot be mandated through regulations of RBI.
"Sectors such as power and real estate were already stressed even before the outbreak of the pandemic on account of various factors pertain to sector-specific problems. For instance, power generation companies face non-payment of dues by the distribution companies or State Governments, non-certainty in power purchase agreements in the medium term, uncertainty in the availability of fuel etc. Real estate sector has undergone structural changes in the recent past and is also facing a demand problem as evident from the high levels of unsold inventories and stalled projects", it submitted.
It is further stated that in any case, projects under implementation which are affected due to the fallout of COVID 19 can be restructured under an already existing framework. This extant framework allows for extention of timeline for completion of the projects by 2 years in case of non-infra projects, including real estate projects, and by 4 years for infrastructure projects without downgrading to NPA.. The Government has also taken several measures to address some of the sectoral problems, including creation of a Special Window for Completion of Affordable and Mid-Income Housing (SWAMIH Investment Fund) to provide priority debt financing for the completion of stalled housing projects. Nonetheless, it is submitted that the travails of real sector cannot be solved through banking regulations. The banking regulations of RBI cannot substitute the addressal of structural problems of the real sector.
Recommendations of Kamath Committee are onerous to implement
Some of the petitioners have argued that the additional financial parameters as notified by the Reserve Bank on September 7, 2020 based on the recommendations of the Kamath Committee are too onerous and difficult to achieve. Further, in respect of one specific financial parameter viz. Total Outside Liability / Adjusted Tangible Net Worth (TOL / Adjusted TNW), while the Committee had recommended compliance by March 2022, the final guidelines issued by the Reserve Bank have advanced the target date for compliance.
It is submitted that the task of identification of the financial parameters and the specification of sector-wise thresholds was undertaken by the Committee after comprehensive deliberations based on detailed analysis of sector specific reports/company data from various sources as well as based on its discussions with the Rating Agencies and lending institutions. Wherever the Committee felt that certain ratios were not relevant or not applicable based on the specific nature of the sector, the Committee itself had recommended a different treatment, for eg. aviation, automobile manufacturing, roads and wholesale trading, which has also been accepted by the Reserve Bank.
In terms of the September 7 notification, lending institutions are required to consider five key ratios – Total Outside Liabilities/ Adjusted Tangible Net Worth (TOL/ATNW), Total Debt /EBITDA, Current Ratio, Debt Service Coverage Ratio (DSCR), Average Debt Service Coverage Ratio (ADSCR) while preparing the financial assumptions in respect of resolution plans under the Resolution Framework. The specific thresholds to be met for these ratios in respect of borrowers in 26 sectors have been prescribed, as recommended by the Expert Committee. As regards all other sectors, the lending institutions may make their own internal assessments with regard to the values of the five ratios to be considered.
"The target levels of the key ratios within the permitted thresholds have to be factored into the financial projections prepared, and the actual performance with respect to the projections will be monitored on an ongoing basis. While the projected ratios in respect of TOL/ATNW should preferably be achieved at the time of implementation itself, an outer limit for achievement has been prescribed as not later than March 31, 2022. The projected levels in respect of other ratios have to be achieved by not later than March 31, 2022", it is averred.
"The parameter thresholds recommended by the Committee are generally more generous than that used in normal times. Further, the ratios prescribed are intended as floors or ceilings, as the case may be, but the resolution plans are required to take into account the pre-Covid-19 operating and financial performance of the borrower and impact of Covid-19 on its operating and financial performance at the time of finalising the resolution plan, to assess the cash flows in subsequent years, while stipulating appropriate ratios in each case. Thus sufficient leeway has already been provided to accommodate the impact of Covid19 while stipulating specific ratios", it is advanced.
IV. NPA CLASSIFICATION
It is submitted that this court had given an across the board stay on classification of any account as NPA till further orders. If the stay is not lifted immediately, it shall have huge implications for the banking system, apart from undermining the regulatory mandate of the Reserve Bank of India.
The Reserve Bank guidelines on 'Prudential Norms on Income Recognition, Asset Classification and Provisioning pertaining to Advances' issued vide Master Circular DBR.No.BP.BC.2/21.04.048/2015-16 dated July 01, 2015 are aimed at reflecting true and fair position of the accounts of banks so that the financial assets (which are public assets) will be accurately reflected in the books of accounts of the lenders.
The classification of a loan account as NPA, based on the record of recovery, actually enables the lenders to follow the regulatory guidelines with regard to income recognition and provisioning.
It is further prayed that the interim order dated September 4, 2020 restraining classification of accounts into Non-Performing Accounts in terms of the directions issued by RBI may be vacated with immediate effect.