Areport on trends in the banking sector issued by the Reserve Bank of India (RBI) on 21 November 2013 put gross non-performing assets (NPAs) of scheduled commercial banks at 3.6% of the gross advances.
In December 2013, the RBI issued a discussion paper titled “Early Recognition of Financial Distress, Prompt Steps for Resolution and Fair Recovery for Lenders”, with a view to increase effi- ciency in monitoring loan accounts. After receiving comments, the RBI introduced a “Framework for Revitalising Distressed Assets in the Economy” for banks and non-banking financial companies (NBFCs) on 30 January 2014.
Based on the framework, the RBI issued specific guidelines for banks on 26 February, titled “Framework for Revitalising Distressed Assets in the Economy – Guidelines on Joint Lenders’ Forum (JLF) and Corrective Action Plan (CAP)” and for NBFCs on 21 March, titled “Early Recognition of Financial Distress, Prompt Steps for Resolution and Fair Recovery for Lenders: Framework for Revitalising Distressed Assets in the Economy”.
These guidelines have introduced an asset classification named “special men- tion account” (SMA). An account is clas- sified as SMA-0 if principal or interest has remained overdue for less than 30 days and the account has shown signs of incipient stress; SMA-1 for a period of 31-60 days; and SMA-2 for 61-90 days. The guidelines require all banks and notified NBFCs to report details of all accounts with aggregate exposure of ₹50 million (US$827,000) and above to the Central Repository of Information on Large Credits (CRILC), which was set up pursuant to these guidelines.
On an account being classified as SMA-2, banks and notified NBFCs are required to mandatorily form a joint lenders’ forum for accounts with aggregate exposure of ₹1 billion and above. The JLF is to be convened and led by the lead bank in a consortium and by the lender with the highest aggregate expo- sure in the case of a multiple banking arrangement. All lenders have to join the JLF under the guidelines, regardless of how small their exposure may be. The guidelines also require the lenders to sign an inter se agreement called the “master JLF agreement”.
The lenders in the JLF are required to arrive and agree on a resolution option to be adopted and devise a CAP within 30 days from the account being reported as SMA-2. The guidelines suggest that the lenders can agree to rectification, restruc- turing or recovery as options. However, the guidelines do not restrict the lenders from exploring other measures.
If the lenders fail to convene the JLF or agree on a CAP within the timeline stipulated under the guidelines, the account will be subjected to acceler- ated provisioning on being classified as a NPA. Accelerated provisioning effectively mandates a greater percentage of provisioning to be maintained by the lenders, thereby serving as a major deterrent for them.
Once a CAP has been finalized by the JLF, the JLF may proceed with imple- mentation of the rectification and recov- ery actions (in accordance with statutory requirements). If restructuring has been chosen as a resolution option, the lenders may opt to sign an inter-creditor agreement (ICA) and a debtor-credi- tor agreement. Once the lenders have signed these agreements, they will be bound by them and any backtracking or delay in implementation of the restructur- ing package will subject the account to accelerated provisioning if the account is classified as a NPA, and may also attract negative supervisory review of the entity.
The biggest issue posed by these guidelines is that all the lenders are effec- tively thrust into the process of the JLF and are at the mercy of the other lend- ers to reach an agreement and avoid accelerated provisioning. Further, the guidelines do not provide any clarity on whether the signing of an ICA is manda- tory or on the consequences of not being able to agree on a restructuring package. Unlike the corporate debt restructuring mechanism, the guidelines do not sug- gest that the ICA becomes binding on all parties if signed by a particular majority percentage. However, the guidelines stipulate that while the restructuring is being finalized, the usual asset classifica- tion norm would continue to apply. The guidelines also stipulate different thresh- olds for decision making as regards restructuring.
Though the intent of the guidelines is to adequately monitor loan accounts, the consequences suggested may have an adverse impact on banks and NBFCs. Several banks and NBFCs are looking to seek clarifications and make representa- tions to the relevant authorities regarding these. In the interim, one can only hope that banks and NBFCs strengthen their credit monitoring standards. Former RBI deputy director KC Chakrabarty has rightly remarked that: “The first and fore- most lesson for all of us is that regulatory forbearance is not a panacea for the ills that afflict the credit management envi- ronment in the banking sector.”
Babu Sivaprakasam is a partner, Deep Roy is an associate partner and Megha Agarwal is an associate at Economic Laws Practice. This ar- ticle is intended for informational purposes and does not constitute a legal opinion or advice.
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