Article. RBI s Framework for revitalising distressed assets leaves everyone in stress Bank, NBFCs, Corporate Inc, CAs, advocates no one s spared

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1 RBI s Framework for revitalising distressed assets leaves everyone in stress Bank, NBFCs, Corporate Inc, CAs, advocates no one s spared Nidhi Bothra nidhi@vinodkothari.com Abhirup Ghosh abhirup@vinodkothari.com 17 th February, 2014 Check at: for more write ups. Copyright: This write up is the property of Vinod Kothari Consultants P. Ltd. and no part of it can be copied, reproduced or distributed in any manner. Disclaimer: This write up is intended to initiate academic debate on a pertinent question. It is not intended to be a professional advice and should not be relied upon for real life facts.

2 The slacking Indian economy is sitting with Rs. 82 trillion of bad loans in the banking system and surely is the cause of concern to the health of the economy. The continuing rise in number of the non performing asset 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 1 on January 30, 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 st 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 Central Repository of Information on Large Credits (CRILC) whereby before an account is declared as NPA, it shall pass through a Special Mention Account. Lenders falling under the framework will have to put in place proper MIS system 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 Rs 50 billion and apart from banks 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 ECB regulations as extended by overseas branches to Indian borrowers. Further, where a borrower account falls under SMA 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-2 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-1 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. 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, personal guarantees from promoters etc. The JLF will also be mandated to adopt the options proposed at CAP within 30 days of account being reported as SMA-2 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 Where the borrower s interest and principal payment due is between days, SMA-0 where principal and interest payment is overdue for not more than 30 days but account shows signs of incipient and SMA-1 is where principal and interest is overdue between days.

3 restructuring process are ineffective then JLF should initiate recovery process which would be CDR guidelines laid down by RBI. Some of the options suggested for loan restructuring is the possibility of transferring equity of the promoters to the 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 accelerated 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: Asset Classification Period as NPA Current provisioning (%) Revised accelerated provisioning (%) Sub- standard Up to 6 months 15 No change (secured) 6 months to 1 year Sub-standard Up to 6 months 25 (other than 25 (unsecured ab-initio) infrastructure loans) 20 (infrastructure loans) 6 months to 1 year 25 (other than 40 infrastructure loans) 20 (infrastructure loans) Doubtful I 2 nd Year 25 (secured portion) 40 (secured portion) 100 (unsecured portion) 100 (unsecured portion) Doubtful II 3 rd & 4 th Year 40 (secured portion) 100 (for both secured 100 (unsecured portion) and unsecured portion) Doubtful III 5 th Year onwards The RBI is to maintain list of directors on board of such companies classified as noncooperative borrowers for dissemination to lenders and RBI shall send out necessary guidelines in this regard later. Banks will also lodge complaints with ICAI against auditors for falsification of accounts/ wrong certification etc. All such CAs against who 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.

4 Currently the banks are not allowed to sell standard assets to the ARCs, but this framework provides that the banks will be henceforth allowed to sell the assets reported as SMA-2 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 NBV to its 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 the banks to spread over any shortfall, in case the sale value is lower the NBV, over a period of 2 years, the latter one will be available for the NPAs sold up to March 31 st, The banks are allowed to use their floating provisions 3 only for contingencies under extraordinary circumstances to the extent of 33% of the floating provisions held by them as on March 31, 2013 (vide its notification dated February 7, ) for making specific provisions in impaired accounts after obtaining board's approval and with prior permission of RBI. With a view to help the NBFCs in clearing up the stressed assets from their books, the RBI has decided to make recommendations to the government for allowing the designated large NBFCs to assign stressed assets to the 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-2 to the CRILC, a JLF is to be formed along with the other lenders. So, what if the borrower is classified as SMA-2 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. 3 Floating provisions are made by the banks which are neither made against any identified losses nor are earmarked against particular loan accounts. 4

5 Conclusion RBI s Framework for revitalising distressed assets leaves everyone in stress Bank, 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. For our write ups on Restructuring, click here. For our write ups on ARCs, click here.