RBI firm on new bad loan resolution framework

Reserve Bank of India (RBI) deputy governor N S Vishwanathan strongly defended its new rules on debt resolution, including the oneday default norm, stating that banks should get into action before any such default takes place and that companies should not take the covenants of a loan contract casually.

“The debt contract embedded in bank loans has been continuously losing its sanctity, especially where the borrowing is large. There is a need to change this and restore sanctity of the debt contract, lest bank debt becomes subordinate even to equity,” said Vishwanathan at the National Institute of Bank Management, Pune.

The new framework aimed to restore the sanctity of such debt contracts, he stressed.

The speech addressed several issues raised by bankers and some government officials. It indicated the RBI was in no mood to move from its stance on the need for a strict framework.

On the contentious one-day default clause, the deputy governor said such defaults already attracted a severe penalty for the borrower in a bond market. So, why cannot that be the case for loans? Especially when banks “access unlimited uncollateralised funding from, among others, common persons, on the strength of the banking licence”.

The deputy governor said even some highly rated borrowers had failed on the one-day default norm. “Non-payment on the due date appears to be seen as par for the course by banks and borrowers,” he commented. And, said bankers should warn their customers that upon such a default, the company would be brought for resolution, and “borrowers, too, should realise that they have to meet payment obligations as per the contract.. .it is no more sufficient to pay up only by 60/90 days past the due date”.

Such a default criterion, coupled with the central database on default maintained by the central bank, would address the bad assets problem in the economy, argued Vishwanathan. Instead of complaining, banks can take pro-active steps much before a loan gets into default.

“If borrowers fail to pay on the due date because of a cash flow problem, banks should see that as an early warning indicator, warranting immediate action. If borrowers with the ability to pay on the due date do delay it routinely or because they see other arbitrage options, that must change, too.”

Of course, there are cases where contractors are paid late, such as with some government bodies. Banks must take into consideration such risks and ink a contract that incorporates these. The borrowers must have enough ‘skin in the game’ and be able to manage any such irregular cash flow and repay.

“The present problem is that banks allow excessively high leverage, thus leaving out any possibility that the borrower can be made to deal with emergencies. This has been possible in an environment in which both the lender and the borrower were not too keen to maintain the sanctity of the

debt contract,” said the deputy governor.

He emphasised that the framework did not apply for borrowers in the micro/small and medium category (MSMEs), with borrowings of ~250 million or less. The rule for MSMEs allows these to delay repayment and even extend the same status for a few years, till they grow in size and are no more considered MSMEs.

The deputy governor also sought to allay the concern that all banks had to have a uniform resolution plan (RP), drawn after the one-day default gets triggered.

“Complete discretion and flexibility has been given to banks to formulate their own ground rules in dealing with borrowers with exposure to multiple banks. In the earlier regime, the RP was mostly the same across banks. Under the revised framework, lenders can implement RPs tailored to their internal policies and risk appetites,” Vishwanathan said.

“Therefore, unlike the perception in some quarters, the new framework does not seek unanimity.”

Some in the corporate sector had raised a concern that as all the banks involved would have to agree on an RP, which generally never happens, the companies in question would have to necessarily be referred for insolvency.

“Let me be crystal-clear. There is a chatter that the new framework mandates unanimity across lenders. The fact of the matter is the exact opposite,” Vishwanathan said.

RBI, in its February 12 circular, did away with all the previous restructuring norms. Instead, it introduced a straightforward framework that says as soon as a company overshoots the 91-day period for coming under the non-performing asset category, it would be considered a defaulter. And, banks will have to come up with an RP to recover their dues. If the plan doesn’t work, the company would have to be referred to the insolvency code’s ambit, in which the promoter risks losing the company.

“If lenders and the stressed borrowers are unable to put in place a credible RP within the timelines, then the structured insolvency resolution process under the Insolvency and Bankruptcy Code should take over,” said Vishwanathan.