Banking on relaxations for commercial real estate loans

By Devyani Dhawan and Jyotika Bajaj, SNG & Partners
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Following the sudden increase of loans to real estate players in the early 2000s and with no effective and orderly risk-management system in place, the Reserve Bank of India (RBI) in 2005 required banks to formulate policies governing real estate exposure. They were instructed to put in place risk management systems and to make regular disclosures to the RBI of their real estate loan portfolios. This included a system of checks where the occurrence of certain events in commercial real estate loans, such as cost overruns and extensions of commercial operation dates, would trigger the reclassification of accounts as sub standard or as non-performing assets.

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Devyani Dhawan
Principal associate
SNG & Partners

The real estate industry has since seen peaks and troughs, and the consequent evolution of the products offered by banks and the regulations governing them. As more instances surfaced of defaults and the consequent classification of loans as non-performing assets the RBI relaxed the classification of loans. In February 2020, the RBI amended guidelines for the commercial real estate (CRE) via a circular (RBI CRE circular). This related to the extension of the date of commencement of commercial operations (DCCO) as well as the availability of loans for funding project cost overruns. This has been done to give assistance to the struggling real estate sector by aligning the guidelines on extensions of DCCO in the CRE sector with those in the non-infrastructure sector.

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Jyotika Bajaj
Senior associate
SNG & Partners

This development stems from the way in which banks treated loans to the CRE and the non-infrastructure sectors in the past. Before the RBI CRE circular, extensions of the DCCO for CRE projects beyond a period of one year from the original DCCO would have resulted in the downgrading of the loan from standard to sub standard in accordance with existing RBI regulations. The RBI CRE circular, however, provides that where the restructuring application is made by the borrower to the lender within one year from the original DCCO, while the loan is still classified as standard, such loan will continue to be so classified. This prevents it from becoming a non-performing asset. The borrower will also be able to raise funds for cost overruns within the extended DCCO without such advances being classified as non-performing assets.

This will provide relief for CRE players in the light of the history of this development. In 2010 a relaxation given to real estate projects in the non-infrastructure sector permitted loans to be classified as standard assets for up to 12 months from the end of the extension of the DCCO from the original DCCO. This concession excluded the CRE sector. After this, in 2014 the RBI, in line with international banking practice permitted the offering of cost overrun loan facilities without classifying the triggering event as the restructuring of loans, provided that such loans were approved as standby facilities before the disbursement of the project loan. Where such cost overruns had not been factored in at the time of initial loan approval, banks were still allowed to provide funding without treating such loans as “restructured assets” subject to satisfaction of certain conditions. However, these guidelines again did not apply to CRE players whose businesses continued to be governed by the Master Circular – Income Recognition, Asset Classification, Provisioning and Other Related Matters issued by the RBI in 2014.

In 2015, the prudential norms on income recognition, asset classification and provisioning applicable to advances for live projects were further liberalized by allowing the rescheduling of repayment schedules as a result of changes in the management of the developer entity. However, this could be done once only for any given project because this step would have been taken to revive projects stalled because of the inadequacies of the current promoters of the developer. The DCCO could be extended further by two years. This benefit again only applied to the non-infrastructure sector and not to CRE.

With the introduction of the RBI CRE circular, similar relaxations are now allowed in the CRE sector. The RBI CRE circular brings about a welcome change for genuine developers who are victims of inordinate delays caused by the government, which result in extensions of the DCCO with the consequent downgrading of loan accounts. However, it should be noted that while the RBI has acted to ease the anxieties of the real estate sector, there is now an additional responsibility on the banks to ensure that borrowers comply with the provisions of the Real Estate (Regulation and Development) Act, 2016 (RERA). Banks, while taking advantage of the relaxations under the RBI CRE circular, must therefore bear in mind the requirements of RERA. They should follow up and check with borrowers that they are complying with its requirements.

SNG & Partners has offices in New Delhi, Mumbai and Singapore. Devyani Dhawan is a principal associate and Jyotika Bajaj is a senior associate.

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