RBI’s Restructuring Framework Needs Deft Finishing Touches To Make It WorkBloombergQuintOpinion
The Reserve Bank of India’s resolution framework for pandemic-related stress provided timely guidance on the possible course of action after Aug. 31, 2020, when the moratorium on loans comes to an end. It may be expected that a majority of borrowers in the moratorium will require some form of restructuring. On a systemwide basis, this may mean one-in-five retail borrowers and one-in-three commercial borrowers.
Adding to the pressure of the scale of this restructuring is the timeframe. The restructuring will have to be invoked by Dec. 31, 2020, with retail and corporate cases getting a further 90 and 180 days, respectively, to implement it. However, certain rules that have been proposed may end up creating a bottleneck, while adding limited value to the process. In the worst-case scenario, it is possible that the exercise is compliant with the rules but fails in terms of meeting the economic objectives.
Five areas need to be addressed.
1. Lenders’ Eligibility Criteria
In principle, borrowers who are impacted by Covid-19 are eligible for getting this restructuring benefit. As per the rule, borrowers who are no more than 30 days delinquent as of March 1, 2020, are eligible. Additionally, as on the date of invocation, they should remain standard. In the potential scenarios laid out below, borrowers with preexisting weak credit profiles may get the restructuring benefit, while genuine Covid-19-impacted borrowers may lose out.
- Borrower ‘A’ had three events of 30 days-past-due in the six months preceding March 1, 2020, but was current on that day. Borrower B was a current customer for 12 months but became 30 days-past-due on March 1. Borrower A is the riskier of the two but will be eligible for restructuring and not Borrower B.
- Some borrowers, severely impacted by the Covid-19 crisis may default between Aug. 31 and Dec. 31 even if they were current as on March 1. Despite being impacted by the pandemic, such borrowers will not be eligible for restructuring.
- Borrowers who become NPA between the invocation and implementation dates.
- Firms that showed signs of credit weakness pre-pandemic, saw stress aggravate due to the near-universal economic impact of the crisis. Such firms and those with the second-order impact of the disruption may not get the benefit of restructuring.
Banks need to have more granular and consistent criteria to capture the spirit of the guideline, to identify covid-impacted borrowers without preexisting credit weakness. The existing rules should be optional with the RBI asking each bank to justify the criteria in identifying the impacted borrower and how consistently it is being applied.
2. Credit Rating Agencies Involvement Optional
Financial statements are a critical input into a credit rating agency’s rating decision. Given the various deadline relaxations provided for statutory filings, a lot of financial statements will be available only after December 2020. Firms with exposures above Rs 100 crore are likely to fall into this category. Since rating agencies will not have an information advantage, the utility of getting a rating before such a restructuring exercise is unclear. On the contrary, banks have a clear information advantage now with access to borrowers’ banking transaction data, stock statements, and the like.
There is no reason to believe that a bank’s inhouse credit rating team, despite having more information, will do a worse job than the rating agency.
Also, given the likely spike in rating requests in a squeezed time window, can rating agencies do a quality job? It appears that the potential bottleneck is more worrisome than the benefit of an external rating.
3. Expert Group As Coordinators
Operational capacity may also make the process of the expert vetting resolutions with exposures above Rs 1,500 crore a bottleneck. The expert group could be better used to resolve disagreements between banks over multiple-lender restructuring plans.
4. Projection Frameworks, Not Magic Ratio
Most seasoned underwriters know what critical financial parameters to look for as well as the acceptable range of those parameters. An expert group, eminent and revered as they are, is unlikely to come-up with elixir financial parameters and magic financial ratios. The downside to having regulatory-guided financial ratios is that one may find firms miraculously meeting those ratios when their projections are made. Expertise is required for projecting the financials for firms under these stressed and evolving economic scenarios.
The expert committee could instead offer guidance on three fronts which would provide at least as much material benefit as financial ratios:
- Propose frameworks that may be acceptable for making financial projections. Offer lists of acceptable techniques, and the extent of volatility and optionality allowable in making this projection to project financials.
- Ensure a coordination and information exchange where banks can make near-consensus financial estimates for the same or similar borrowers. Here banks can leverage cumulative intelligence which is way more powerful than some pre-fixed industry-specific ratio.
- Surveillance frameworks may be required to check the actual performance against projections and trigger covenants.
5. Overarching Economic Principles Over Narrow Rules
The Reserve Bank has stated that this is a principle-based framework. A rule-based regulatory framework may face challenges in implementing such a complex exercise during an extremely uncertain and stressful economic situation. The regulator may not be faulted if certain elements of rule-based regulations have crept in, given the banking sector’s questionable success with restructuring in the past.
What the regulator may have inadvertently missed is declaring some overarching economic objectives for the restructuring, and financial principles that will supersede any of the rules.
One example of such a principle is that every restructured loan should strive to maintain the economic value of the original loan; in case of a reduction in value the shortfall to be met by provisioning.
The RBI would come closer to its stated principle-based approach if some of the proposals discussed in this article are considered. The resultant ease of execution is likely to improve the scope of success of the restructuring initiative. As such, compliance with narrow rules is not a replacement for robust economic decision making. Watchful stakeholders reacting to transparent timely data is more effective in getting the best out of banks.
Deep Narayan Mukherjee is a financial services professional and a visiting faculty on risk management at Indian Institute of Management, Calcutta.
The views expressed here are those of the author and do not necessarily represent the views of BloombergQuint or its editorial team.