RBI’s framework for revitalising distressed assets leaves everyone in stress. Banks, NBFCs, India Inc, CAs and advocates, no one is spared

The slacking Indian economy is sitting with huge pile of bad loans (estimated to be about Rs2.9 lakh crore) in the Rs82 lakh crore banking system and surely is the cause of concern to the health of the economy. The continuing rise in number of the non-performing assets (NPAs) and restructured cases in the banking system made the Reserve Bank of India (RBI) came out with a “Framework for revitalising distressed assets in the economy” on 30 January 2014 to recognise early signs of distress, catalyse the restructuring process, quicker distress resolution planning, leveraged buyouts, take-out financing and more. The framework will be effective from 1 April 2014 and the banks and the non-bank lenders will be required to put in place the necessary infrastructure to implement the Framework.

The framework requires ‘Early Recognition of Stress’ and setting up of a Central Repository of Information on Large Credits (CRILC) whereby before an account is declared as NPA, it shall pass through a ‘Special Mention Account’ (SMA). Lenders falling under the framework will have to put in place proper management information system (MIS) to ensure the SMA triggers are captured as they are breached.

The CRILC will collect data of the borrowers having aggregate fund and non-fund exposure of more than Rs500 crore and apart from banks, non-banking financial companies- systemically important (NBFC-SIs) and NBFC-Factors will also be required to furnish data. Apart from these, eligible lenders in India will be required to report lending under external commercial borrowing (ECB) regulations as extended by overseas branches to Indian borrowers.

Further, where a borrower account falls under SMA-II, banks and notified NBFCs will be required to mandatorily form a Joint Lenders’ Forum (JLF) and formulate Corrective Action Plan (CAP). Any lender reporting an account as SMA-II will trigger the formation of JLF. RBI may also in due course require banks to form the JLF and formulate CAP if the borrower account is SMA-0 for three quarters in a year or SMA-I for two quarters during a year.

Where a borrower requests for formation of JLF on account of imminent stress, the lenders will report that account as SMA-0 to CRILC. Indian Banks' Association (IBA) is required to prepare the Master JLF agreement and the operational guidelines for JLF to be adopted by all lenders.

The CAP by the JLF will include identifying ways of regularising the account and ensuring that it does not slip into SMA-0, which will include analysing the need for strategic investor, equity participation from outsider, need for additional finance to the borrower and personal guarantees from promoters.

The JLF will also be mandated to adopt the options proposed at CAP within 30 days of account being reported as SMA-II or from the receipt of request from borrower and the detailed CAP to be signed off from within the next 30 days. If either of rectification or restructuring process are ineffective, then JLF should initiate recovery process, which would be as per the corporate debt restructuring (CDR) guidelines laid down by RBI.

Some of the options suggested for loan restructuring is the possibility of transferring equity of promoters to lenders to compensate for their sacrifice or requiring promoters to infuse more equity or transferring the promoters’ shareholding into escrow till the turnaround happens. This would mean where the account is showing signs of NPA due to whatever reasons, there is threat to the sweat equity of the promoter being snatched from him.

In case, banks and notified NBFCs don’t adhere to the SMA classification norms, they will be subjected to accelerate provisioning and other supervisory action as may be deemed appropriate by RBI. Also once a lender has agreed on the CAP by the JLF but changes stance later on or delays the implementation package will also be subject to accelerated provisioning norms as mentioned below:
 

The RBI is to maintain list of directors on board of such companies classified as non-cooperative borrowers for dissemination to lenders and RBI shall send out necessary guidelines in this regard later. Banks will also lodge complaints with the Institute of Chartered Accountants of India (ICAI) against auditors for falsification of accounts or wrong certification. All such chartered accountants (CAs), against whom complaints are received and the disciplinary action is pending, may be flagged for information of all banks. Banks will consider sharing their names with other regulators for more information. Similar would be the fate for advocates, clearing the title of the assets wrongly and valuers, who have overstated the value of the security.

Currently banks are not allowed to sell standard assets to asset reconstruction companies (ARCs), but this framework provides that the banks will be henceforth allowed to sell the assets reported as SMA-II to the ARCs. With a view to incentivize the early disposal of stressed assets to the ARCs, RBI has decided to allow the banks to reverse the excess provision on sale of NPA if the sale is for a value higher than the net book value (NBV) to its profit and loss (P&L) account in the year, the amounts are received, so that the banks can recover the appropriate value in respect of their NPA. Further, it will also allow banks to spread over any shortfall, in case the sale value is lower the NBV, over a period of two years, the latter one will be available for the NPAs sold up to 31 March 2015. Banks are allowed to use their floating provisions only for contingencies under extraordinary circumstances to the extent of 33% of the floating provisions held by them as on 31 March 2013 (vide its notification dated 7 February 2014 ) for making specific provisions in impaired accounts  after  obtaining  board's  approval  and  with  prior  permission  of  RBI.

With a view to help NBFCs in clearing up the stressed assets from their books, the RBI has decided to make recommendations to the government for allowing designated large NBFCs to assign stressed assets to ARCs under the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interests Act, 2002 (SARFAESI Act).

Trail of questions to be answered

Like many other guidelines by the RBI, we think even this framework has few of uncertainties which we have laid down below:

• The framework states that as an account is reported as SMA-II to the CRILC, a JLF is to be formed along with the other lenders. So, what if the borrower is classified as SMA-II with only one bank and not with the other lenders – will the other lenders still have to agree for the formation of a Joint Lenders’ Forum?

• If a lender disagrees to join the Joint Lenders’ Forum, what consequences will it face? Further, what will be its claim in the cash flows?

• It has been clearly written in the framework that along with the banks, notified NBFCs will also have to comply with the provisions laid down for the SMA classification, but the timeframe for classification mentioned in the framework lacks parity with the NBFC prudential guidelines. Unlike the banks, the NBFCs classify NPAs in their books only when the principal and interest remains overdue for over 180 days, so, ideally their mode of SMA classification should have been different from that of the banks.

It is very evident from this framework, that the RBI is looking forward to minimise the existing stress in the economy through every possible way. Moreover, it has decided to encounter the artificial stress created on the assets with strict measures for the promoters and directors of the borrowers, the auditors, the advocates and the valuer. None is spared under this framework.

(Nidhi Bothra is executive vice president, while Abhirup Ghosh is research analyst at Vinod Kothari & Company)