General Studies Paper 3 (Indian Economy): Prudential framework for resolution of stressed assets

ReserveBankofIndia

IAS Junior Mains Answer Writing June-Sep 2019 Schedule (Click Here)

 

Syllabus: General Studies Paper 3 (Indian Economy)

 

Examine the significance of ‘prudential framework for resolution of stressed assets’ that were recently released by RBI.

 

Introduction:

The Non-performing Assets (NPAs) or bad loans of banks have increased to alarming levels. Currently, the NPA ratio in Indian banks stands at 9.45 % of gross loans. The RBI has overhauled its stressed asset resolution framework to ensure speedy resolution of bad loans in the future. The prudential frame work for resolution of stressed assets is released by RBI with a view to providing a framework for early recognition; reporting and time bound resolution of stressed assets.

 

Body:

What is stressed assets?

Stressed assets = Non-performing Assets (NPAs) + restructured assets + written-off loans.

  • The NPAs are assets that have stopped generating income for a bank. Bank’s assets comprise of loans. When these loans are on the verge of default (that is, about to go bad), they are classified as NPA. In India, a loan is classified as NPA, if the interest or any instalment on the loan remains unpaid for a period of more than 90 days.
  • Restructured loans/ assets are loans of which the terms and conditions have been modified. (like repayment period increased, interest rate reduced, loan converted into equity etc.)
  • Written-off loans are the loans (NPAs) that have been taken off from the balance sheet to clean off the books.

 

Prudential framework for resolution of stressed assets

The new framework is aimed to facilitate the stressed asset resolution in the context of the launch of the Insolvency and Bankruptcy Code 2016.

 

Features of new frame work

  • Notable feature of the new framework is that most of the requirements for resolution has become more stringent.
  • Strict regulations regarding reporting of stress by large borrowers
  • Vigilant policies by the lenders who undertake resolution of stressed assets
  • Strong conditions for the implementation of resolution plans
  • Revised prudential norms for restructuring under IBC and non-IBC
  • Penalties for concealment of stressed assets 
  • As part of the new framework, four earlier stressed asset resolution schemes/guidelines – S4A, JLF (Joint Lenders Forum), CDR (Corporate Debt Restructuring) and SDR (Strategic Debt Restructuring) were withdrawn

 

Details of new frame work

  • Early identification and reporting of stress
    • For the identification of early stress, the RBI already designed the Special Mention Account (SMA) categories. The SMA status for early stress are expressed in term of number of days before an asset reaching NPA status. The SMA classification is given below.

Table: SMA classification

SMA Sub-categoriesPrincipal or interest payment or any other amount wholly or partly overdue between
SMA-01-30 days
SMA-131-60 days
SMA-261-90 days
  • Implementation of Resolution Plan (RP) by the lenders

Under the framework, all lenders must create Board-approved policies for resolution of stressed assets. It also includes the timelines for resolution. As soon as there is a default by the borrower with any lender, all lenders – individually or jointly – shall initiate steps to cure the default. The Resolution Plan shall be clearly documented by all the lenders.

  • Implementation Conditions for Resolution Plan

The new framework brings stricter conditions for the implementation of RP. a resolution plan will be implemented by the lender if:

  • The borrower entity is no longer in default with any of the lenders; and
  • in case of restructuring, all documentation of agreements between the lenders and borrower should be completed.

Independent credit evaluation should be obtained by the borrower in case of restructuring of large accounts (more than Rs 1 billion).

  • Timelines for Large Accounts to be Referred under IBC

For accounts with total exposure of the lenders at Rs 20 billion and above, on or after March 1, RP shall be implemented as per the following timelines:

  • If in default as on the reference date, then 180 days from the reference date.
  • If in default after the reference date, then 180 days from the date of first such default.

If Resolution Plan is not implemented, then lenders should file insolvency application.

 

Significance of the new stressed assets resolution framework

  • The new framework will strengthen the banking system by bringing in much-needed transparency.
  • Though it will increase Non-performing assets (NPAs) of the banks in the coming quarters, it will be positive for the banks in the long run. The banks will not be able to delay the recognition of an asset as non-performing due to the strict guidelines requiring faster recognition and resolution of stressed assets.
  • There have been large divergences in the bank’s and RBI’s assessment of NPAs. SBI reported a divergence of Rs.23239 crores at the end of March 2017. These divergences will not occur if the new framework is implemented properly.
  • But, the increase in NPAs will require increased provisioning as well which will further hit the profitability of the banks in the short run. This is a transition pain which is inevitable.
  • It will inculcate discipline in the corporate sector and end the culture of default that is pervasive currently. The banks will also become more prudent in lending
  • But, as per the new framework, all lenders must agree on the resolution plan. It is difficult to reach consensus if there are many lenders/ banks involved.
  • It could affect business sentiments as genuine defaults will be handled in the same way.
  • It will also hamper credit growth in the short run.
  • extension of the circular to non-bank finance companies (NBFCs) will help align the loan loss provisioning norms for the large stressed accounts of NBFCs with commercial banks.

 

Loop holes in the frame work

  • It does not address the issue of a lender who wishes file independent IBC proceedings in the pendency of the implementation period of the restructuring plan (or the Review Period).
  • The solution for above problem will be via judges applying a common-sense interpretation and imposing a “moratorium” on IBC proceedings – while the lenders try implement a restructuring
  • Certainly, we expect some litigation in this regard,
    • Courts to facilitate a restructuring under the Revised Circular and prevent dissenting lenders from frustrating the objectives of the Revised Circular i.e. uphold a sensible timeline / process toward a flexible restructuring over an insolvency
    • The standard-form ICAs to appropriately rein in dissenting domestic lenders in India
  • The restructuring of debt of listed companies in terms of the Revised Circular involving issue of equity shares or other convertible instruments in favour of local banks will enjoy certain exemptions from SEBI prescribed pricing on preferential allotment and mandatory tender offer requirements. However, the same benefit in case of issue of new capital / change of control (pursuant to an approved restructuring) will not be made available to other strategic and financial investors.

 

Conclusion:

The current framework will sustain the improvements in credit culture that have been ushered in by the efforts of the Government and the Reserve Bank of India so far and that it will go a long way in promoting a strong and resilient financial system in India. The number of cases going into bankruptcy might come down but banks will still use this route if they don’t find a resolution within the timelines otherwise their provisioning cost will go up. IBC is an important reform that works as a threat to owners of companies of losing control of their company. So the role of IBC will continue to be important in bad loan resolution.

 

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