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Debunking Banking Myths: After bad debts, how loan recast impacts lenders’ bottomline?

Author: Dasari Sreenivasa Rao/Wednesday, August 12, 2020/Categories: Exclusive

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Debunking Banking Myths: After bad debts, how loan recast impacts lenders’ bottomline?

Continuing its accommodative stance, the Indian banking regulator has concluded the loan repayment moratorium phase and favoured the loan restructuring proposal for retail and corporate borrowers. The latest move came at a time when Indian banking sector wrote off Rs2.54 lakh crore of bad loans and banks are in the process of making provisions to streamline the balance sheets. It helped the banks lower stressed loans by 8.5 per cent. Reserve Bank of India (RBI) will set up a platform under prudential framework to implement the debt restructuring plan for corporate loans and personal loans. Now, the billion dollar question is how the one-time loan restructuring will impact the domestic banking sector?

India’s real GVA (gross value added) contracted 7.0 per cent YoY in June 2020, its fourth successive decline, which implies that economic activity shrank 18.7 per cent YoY in 1QFY21. According to CMIE study, India lost 12.2 crore jobs in domestic economy and unemployment rate rose to 27 per cent from March onwards.

Monetary policy committee (MPC) of RBI on August 6 retained key rates- Repo rate at four per cent and Reverse Repo at 3.35 per cent and Bank Rate at 4.25 per cent- and announced loan restructuring plan. Personal loans, gold loans, home loans, vehicle loans, education loans, etc., come under the proposal. However, the loan restructuring plan is applicable for those who availed the loans before March 31, 2020, and not defaulted any EMI till March 1. Banks are told to invoke the framework before December 31, 2020, and implement within 90 days from the date of invocation. The six-month moratorium, extended in two tranches on March 27 and May 22, will be concluding on August 31.

Indian economy grew 3.1 per cent in Jan-March quarter of 2020. Average growth for FY21 is projected to be negative (-)4.8 per cent and two-digit contraction in the second quarter (April-June) of the current fiscal.

What’s Loan Restructuring?

It’s a process to rejig the terms and conditions of loans. To keep up the economic activity as the nation is undergoing Unlock 3.0, the Narendra Modi sarkar favoured the loan restructuring proposal. As part of the rescheduling loan repayments, banks can convert any interest accrued or to be accrued into another credit facility. Banks have freedom to enhance the loan tenor as well.

How it’ll impact the personal loans. For instance, the borrowers of gold loans can take more amount upto 90 per cent of the value as against the existing 75 per cent. The permissible loan to value ratio (LTV) enhanced under the restructuring proposal.

Industry bodies welcomed the announcements pertaining to increase in the permissible loan to value ratio for loans against pledge of gold ornaments and jewellery for non-agricultural purposes from 75 per cent to 90 per cent as it’ll ensure greater support to households, entrepreneurs and small businesses.

Once again PSBs need to go for provisioning

The public-sector banks (PSBs) will have to enhance their provisioning buffer factoring in the incremental provisioning requirement on restructured loans and potential NPAs. On the other side, RBI is keen to avoid rampant and unviable restructuring for borrowers. The apex bank has directed banks to make high provisions at 10 per cent on restructured retail/corporate loans and 20 per cent against on corporate loans for banks outside inter-creditor agreement.

As a result, high provisioning cost will discourage unwarranted restructuring. But this would put more pressure on the PSBs to accelerate the pace of increasing their provisioning buffer or disallow restructuring, even in genuine case of stress due to the Covid-19 pandemic.

Emkay Global Financial Services in a report said that “considering Covid-19-induced stressed loans at 10-15 per cent and at least 50 per cent restructured in the worst case, our rough calculations show systemic level immediate additional provisioning cost at 10 per cent could be 50-75 bps.”

This calculation puts debt recast in favour of lenders as select banks would fare better while restructuring loans under stress owing to the pandemic. While ICICI/Axis carry contingent provisions of 125-130 bps, HDFCB/KMB/IIB/RBL have around 60 bps. But large PSBs have contingent provisions of just 10-15 bps.

“Surely, few banks will have to increase their provisioning buffer, factoring in the incremental provisioning requirement on restructured loans and potential NPAs. The provision required for restructured loans, however, provides for reversal of 50 per cent of provisioning on retail loans in case the borrower pays 20 per cent residual debt, and the balance 50 per cent on payment of another 10 per cent without slipping into NPA,” says Emkay Global Financial Services.

Impact on Asset Quality

Analysts forecast that debt restructuring will help the banks soften the impact on the asset quality as majority of borrowers are under Rs500 crore corporate loans. The one-time loan rescheduling will further enable banks to restrict the rising bad loan component. Corporate sector will be benefited in forms of loan tenor extension, additional credit facility and a possible moratorium upto two years. Further, banks would provide 10 per cent against loans set for restructuring under the plan. Lenders are allowed to convert unpaid debt into any other non-equity security.

Rajnish Kumar, chairman of Indian Banks’ Association (IBA) and SBI chief, said: “Notably, the RBI has addressed the need to offer some form of restructuring facility for standard accounts that are facing difficulty in debt restructuring.”

Companies with NPA should be given one-time loan restructuring plan provided their business is viable to come out of the Covid-19 impact, said a Hyderabad-based CEO.

KV Kamath-led panel on debt recast

RBI has constituted of an expert committee led by KV Kamath to make recommendations on a special window for Covid-19-related stressed assets under the banks’ Prudential Framework on Resolution of Stressed Assets. Diwakar Gupta will join the panel with effect from September 1, 2020, after the completion of his term as V-P at Asian Development Bank (ADB). TN Manoharan will join the committee from August 14, 2020, after completion of his term as Canara Bank Chairman.

Ashvin Parekh, Managing Partner at Ashvin Parekh Advisory Services, and the Indian Banks’ Association (IBA) CEO will be the strategy adviser and member-secretary respectively. Former Punjab National Bank CEO Sunil Mehta is the current CEO of IBA.

RBI Governor Shaktikanta Das had announced that in order to facilitate the revival of economic activities and mitigate the impact on ultimate borrowers, a window will be provided under the ‘Prudential Framework’ to enable lenders to implement a resolution plan in respect of eligible corporate exposures without a change in ownership, and personal loans, while classifying such exposures as standard, subject to specified conditions.

The Kamath-led panel will make recommendations, within 30 days, on the required financial parameters to be factored into the resolution plans, with sector-specific benchmark ranges for such parameters.

“The expert committee shall also undertake the process validation for the resolution plans under this framework, without going into the commercial aspects, in respect of all accounts with aggregate exposure of Rs 1,500 crore and above at the time of invocation,” says RBI in a statement.

The committee will submit its recommendations on the financial parameters to the RBI, which in turn, will notify the same along with modifications, if any, within 30 days. The IBA will be Secretariat for the committee that is fully empowered to consult or invite any person it deems fit.

The panel may devise its own procedures for its functioning. It will function under the aegis of the RBI. Accordingly, its expenses and those of its Secretariat will be borne by the apex bank. The committee may be expanded to include more members as and when necessary.

GNPA ratio may swell to 14.7% in FY21

The Covid-19 outbreak continues to worsen bad loan scenario in the domestic banking sector. The latest Financial Stability Report from RBI holds view that gross non-performing assets (GNPA) ratio of Indian banks may increase to 14.7 per cent by the end of the current fiscal, in case the stress scenario severely worsens. Under the baseline scenario, the gross NPA may increase to 12.5 per cent by March 2021. At the end of the FY20, the gross NPA ration was at 8.5 per cent, according to RBI.

“Macro stress tests for credit risk indicate that the GNPA ratio of all SCBs may increase from 8.5 per cent in March 2020 to 12.5 per cent by March 2021 under the baseline scenario; the ratio may escalate to 14.7 per cent under a very severely stressed scenario,” RBI said in the report.

Already economists voiced concerns over the negative impact of the loan moratoriums and collateral free loans announced in the recent economic package as it would lead to more stressed assets and weaken the asset quality of the banks.

As per the RBI report, the capital to risk-weighted assets ratio (CRAR) of scheduled commercial banks (SCBs) edged down to 14.8 per cent in March 2020 from 15.0 per cent in September 2019, while their gross non-performing asset (GNPA) ratio declined to 8.5 per cent from 9.3 per cent and the provision coverage ratio (PCR) improved to 65.4 per cent from 61.6 per cent over this period.

It noted that bank credit, which had considerably weakened during the first half of 2019-20, slid down further in the subsequent period with the moderation becoming broad-based across bank groups. The ongoing slowdown in the economy may impact businesses. Union Finance Minister Nirmala Sitharaman said that the government’s focus was on loan restructuring.

“The focus is on restructuring. The Finance Ministry is actively engaged with the RBI on this. In principle, the idea that restructuring may be required is well taken,” said Nirmala Sitharaman.

Majority of industry players and business chambers are requesting the Centre for a one-time restructuring of loans in the wake of the economic slowdown caused by the Covid-19 pandemic, and the probability of companies not being in a position to repay their dues.

Nirmala Sitharaman is also assuring the India Inc about the engaging all the stake holders in the decision making. She also noted the requirement of extension of the moratorium or a restructuring for the hospitality sector and said that the government is working with the RBI on that front.

“I fully understand the requirements of the hospitality sector on extension of the moratorium or restructuring. We are working with RBI on this,” the FM said.

On the ECLGS scheme for MSMEs, banks can’t refuse credit to MSMEs covered under emergency credit facility and in case of any refusal, such instances must be reported to the union finance ministry. On the trade front, reciprocal arrangements are being considered with other countries for which India has opened up its markets. “Reciprocity is a very critical point in our trade negotiations,” said the FM.

What India Inc Seeks

The domestic industry has been suffering from sluggish demand as the country is undergoing Unlock 3.0. Further, the cash flows still yet to improve for the industry and business firms. Dr Sangita Reddy, president, Ficci, said: “We stand encouraged by the guidance being provided by the Central Bank amid the current environment of continued uncertainty. Weak demand has been the key pain point for businesses and all levers need to be used to get consumption back on track. Front loading at least another 25 bps cut in the repo rate would have been well timed. The festive season has already set in and a cut in the repo rate would have given some guidance to businesses and consumers.”

While congratulating the decision on restructuring of loans in the monetary policy, Dr Reddy said that “we keenly look forward to details and execution.”

RBI announced the restructuring of MSME loans that were in standard category till March 1, 2020, and for setting up committee under KV Kamath to work on resolution framework under June 7 circular.

There has been a spurt in inflationary pressures. However, much of the stress in prices is on account of food led by lock down induced supply side distortions. Going ahead, as these constraints ease, the pressure on prices will subside and be back on RBI’s indicative trajectory.

“We also acknowledge the impact of liquidity measures listed out by the RBI Governor. There has certainly been an improvement in the transmission of the past rate cuts. However, the feedback we have received from ground indicates that banks continue to remain risk averse. We would urge the banks to extend a lending arm in letter and spirit. Given that a sense of uncertainty continues to prevail for businesses, a comforting approach by the banks at this juncture is extremely critical,” added Dr Reddy.

“The review of the priority sector guidelines is applauded. The incentive framework laid out with the objective of minimizing regional disparities is a step in the right direction. We also welcome the broadening of the scope of priority sector lending to include start-ups and inclusion of solar power and compressed biogas plants under the renewable energy limits. In fact, Ficci had been asking for these inclusions for some time now,” said Dr Reddy.

Credit Enhancement To NBFCs

The Centre plans to give the go-ahead for a new credit enhancement to Non-Banking Finance Companies (NBFC) enabling NBFCs to act as a guarantor for lower-rated bonds issued by infrastructure companies to help them raise funds at competitive rates.

DK Aggarwal, president, PHD Chamber of Commerce and Industry, said: “RBI’s announcement of allowing stressed MSME borrowers to restructure debt if their loans were classified as standard as on March 1, 2020 is highly appreciable and would go a long way in strengthening the financial position of the MSMEs.”

A credit enhancement structure or a company helps in lifting the ratings of a specific project or a Special Purpose Vehicle (SPV) executing that project, making it easier for them to mobilise funds from the market at attractive rates.

The need for credit enhancement has become acute during the Covid-19 pandemic as infrastructure companies are under stress and need necessary support to enhance the ratings of their projects and ensure adequate liquidity required for fresh investments.

Though the operation of a Credit Guarantee Enhancement Corporation has been revised in view of similar operations being currently offered by a few government agencies, a dedicated structure plan has not been junked and the Centre will go ahead with a new NBFC after further discussions and at an appropriate time.

It is expected that the credit enhancement structure would take shape as planned earlier, wherein infrastructure financing firm India Infrastructure Finance Co Ltd (IIFCL) in a joint venture with the National Housing Bank (NHB) the and National Bank for Agriculture and Rural Development (Nabard) would set up a SPV known as National Infrastructure Credit Enhancement Ltd (NICE).

The central government in 2019 provided seed capital of Rs 500 crore to operationalise the SPV, but ever since the project has been delayed over further reviews by an inter-ministerial committee.

Senior officials in Finance Ministry feel that it’s the right time for the new entity to come into force as it will help several infrastructure projects to take off which otherwise are stuck due to liquidity issues.

In its ‘Atmanirbhar Bharat’ package, the government has already introduced a 100 per cent Emergency Credit Line Guarantee Scheme (ECLGS) for MSMEs to ensure adequate liquidity to the segment hit hard by the Covid-19 outbreak. Also, a partial guarantee for stressed MSMEs has been provided for.

However, infrastructure projects entailing large investments will gain a lot from a dedicated credit enhancement entity. The SPV will ensure that the Rs 100 lakh crore investment required in infrastructure over the next five years.

The implementation of Credit Guarantee Enhancement Corporation, for which regulations notified by the RBI, has been delayed as against earlier schedule in 2019-20. As per the blueprint of the proposed corporation finalised by the government earlier, the IIFCL will hold 22.5 per cent stake in the new NBFC while the NHB and Nabard could pick up to a 10 per cent stake each.


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