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Economy

RBI Suggests Large Penalties for Restructured Loans

RBI has, in its draft guidelines, made it more difficult for banks to restructure loans. (See: What is loan restructuring?)

Suggested in the guidelines are:

  • Two months from now, from March 2013, banks will have to provision for 5% of restructured loans. The current provisioning need is 2.75%.
  • This applies to new restructured loans that are classified “standard” (i.e. non NPA)
  • Existing standard loans that have already been restructured, which carry the 2.75% provision, will slowly be incremented to the 5% number over two years. By March 2014, banks will provision 3.75% of such loans, and by March 2015, the full 5%. They will need to up provisions every quarter.

Curbing Cunning Stunts

The hit to a bank when a loan is restructured is the “dimunition in fair value” and the calculation was routinely gamed by banks to take a lower hit. RBI has plugged some of the loopholes in the process such as a better definition for term premium before and after restructuring, limiting “financial engineering” through complex structures to avoid fair value dimunition etc.

Banks currently tend to upgrade a restructured account from NPA back to standard even if the account pays the interest on even a small portion of overall outstanding debt. This results in the writing back of the higher provisions required. For example if I have an account that has borrowed 100 crores in multiple facilities (term loan, credit line, bank guarantee etc.) and it is an NPA, I have to provision at least 15% for it (Rs. 15 crores) which hits my profit. If I restructure the loan to pay back interest over 10 years, and the company pays back interest of just Rs. 10 lakhs on a bank guarantee of 1 crore, I can (after a year) classify the whole account as standard, even though interest/principal on the majority of outstanding amount is still not paid!

The new guidelines plug this loophole by only allowing upgrades of restructured NPAs if all interest and/or principal on all outstanding facilities gets paid properly, and then, only a year after the payment on the longest moratorium loan in the same account.

Additionally, the total time for restructuring to work completely currently has an upper limit of 7 years (10 years for infra projects – Suzlon has recently gone this route). This has been changed to 5 years (8 for Infra).

Company and Promoter Impact

Promoters will need to bring in at least 2% of the outstanding debt (or 15% of what the banks give up) in the restructuring process.

Further, lenders can only convert a maximum 10% of the debt into equity, and that too only as a last resort. Remember, in Kingfisher Airlines’ case, banks and other lenders had converted 1,355 cr. worth of debt to equity (about 20%).

What is Loan Restructuring?

When a company can’t pay a loan back, a bank may decide to decrease the interest rate of a loan (reset) or increase the tenure or repayment numbers (recast) or both. Why? Because otherwise the bank may not even get anything, and have to go through a complicated court procedure for years.

Restructuring may involve a hit to the bank (it would get lesser money than earlier thought). Further it could be used as a mechanism to delay recognizing a bad loan, since provisioning requirements are lower for restructured loans versus “bad” loans. RBI therefore has strict guidelines on how such loans should be handled, and the above guidelines are to curb abuse or provide clarity.

Impact

These are draft guidelines and things can change. Current bank impact may not be much, but it’s estimated to be between 3% and 5% of profits. But the down-cycle is only starting now and as more and more bad assets appear, the hit by restructuring is going to be quite heavy. We must of course wait for the final guidelines – till then, it doesn’t make sense to measure impact.

  • Hi Deepak,
    I happened to read this article and your earlier articles titled “India’s broken interest rate transmission” of June/July last year where you were asking the RBI to penalise/ dis-incentivise restructuring.
    The RBI’s norms on restructuring of Feb this year almost sound like ICICI’s punchline “Aap ne chaaha, humne kiya”. Sahi hain boss!