Monday, October 31, 2016

Attempt at Easing Out the NPA Crisis: An Analysis of the RBI’s Reform Efforts

[The following post is contributed by Neelasha Nemani, who is a 5th year student at National Law University Odisha (NLUO), Cuttack.]

The “bad loan crisis” that has gripped India’s large banking sector didn’t just happen overnight. This problem has long since been the elephant in the room; in other words, it has been the most obvious impending risk that neither the legislature nor the regulator seemed to have acknowledged until it got much worse. This post seeks to delineate the efforts of the Reserve Bank of India (“RBI”) in easing out the current crisis, with particular focus on an analysis of its Strategic Debt Restructuring Scheme, 2015 (“SDR”) and the Sustainable Structuring of Stressed Assets Scheme, 2016 (“S4A”).

The SDR Scheme

In 2014, the RBI introduced the Framework for Revitalising Distressed Assets in the Economy – Guidelines on Joint Lenders’ Forum and Corrective Action Plan, 2014 in which a change of management in the stressed borrower company could be envisaged as a restructuring plan to assist lenders in their attempt to recover bad loans. In line with these guidelines, the RBI on June 8, 2015, introduced the SDR Scheme according to which a consortium of lenders, also known as Joint Lenders’ Forum (“JLF”), converts a part of its stressed loan in the ailing borrower company into equity, with the consortium owning at least 51% stake in the company.[1]

This scheme essentially seeks to give banks the opportunity to take over the management of the ailing company and turn it around to make it a viable project within 18 months, after which it would sell its stake to a new promoter. Banks, through this form of restructuring, seek to realize their stressed assets, since the asset can be re-categorized as a Standard Asset[2] once its stake in the company has been sold. The scheme also provides for a regulatory relaxation to the banks during this 18-month period wherein:

1.         The bank is not required to observe the requisite provisioning norms[3] to support the asset undergoing reconstruction, thereby retaining existing cash flows.

2.         The bank is permitted to charge the interest earned from the reconstruction on accrual basis[4] and will not have to wait until it is actually realized.

However, while theoretically speaking this scheme may have been envisaged as a solution to the growing problem of Non-Performing Assets (“NPAs”), it also comes with its own set of problems as far as its practical implementation is concerned:

1.         The 18-month window given to the banks is too short a period within which the bank could be expected to efficiently run the business and manage its restructuring as well as find a new buyer. The banks’ tasks include valuing the company, converting part of its debt into equity, preparing a restructuring plan for an overhaul, etc. Simultaneously, they also have to work on identifying a new promoter who itself, for the purpose of acquisition, will have to conduct its own due diligence of the company, conduct valuation, complete the requisite formalities in respect of the acquisition, etc. For all of this to be completed successfully within 18 months seems quite unrealistic.

The downside of this scheme is that if the lenders are unsuccessful in selling their stake and exiting the company within 18 months, the regulatory relaxations discussed above cease to exist and the banks will be required to comply with the provisioning requirements for the total outstanding debt with retrospective effect, from the date of the first restructuring, in one quarter. Needless to say, the SDR route is not advisable if the banks are not certain of being able to sell their stake within the said 18-month period. Further, the scheme does not provide for a partial sale either. Hence, trying to find a buyer for a majority stake in an ailing company, especially within such a short period, is very difficult. The scheme also requires that the promoter should be unrelated to the original promoter or promoter group of the company, thereby adding to the complexity.

As a response to this criticism, the RBI has recently amended the requirements, providing that the banks will no longer have to sell their entire 51% stake in order to upgrade the status of the concerned asset to a Standard Asset, and will only have to sell 26% of their stake to a new promoter.

2.         Due to their lack of expertise, banks find it extremely difficult to engage in the management of companies. Therefore, it has been seen in most cases that they continue with the existing management of the borrower company and only exercise external supervisory control over the affairs of the company, making it less attractive for a new promoter.

3.         Upon acquiring the controlling stake of 51% in a listed company, the new promoter will be required to make an open offer of 25%. If the open offer is fully subscribed to, the buyer will be the effective holder of 76% stake in the company, triggering the delisting of the company due to SEBI’s minimum public float requirements. In such a situation, no new promoter would be encouraged to purchase the 51% stake in the company owing to the fact that delisting would impact the promoter’s liquidity. While banks have been given the exemption of having to delist the company, new promoters have not been provided this comfort.

Statistics reveal that out of the total 21 cases of SDR that were invoked, only two were successfully closed in the last 14 months since the inception of this Scheme. Due to the above problems, it has been pointed out that this scheme only causes an ever-greening of NPAs by delaying their re-categorization into NPAs by a few years and will not actually solve the issue at hand.

The S4A Scheme:

In order to further strengthen the lenders’ ability to deal with bad loans, the RBI had, on June 28, 2016, introduced the S4A scheme alongside the SDR scheme. According to these guidelines, banks can bifurcate the debt of the borrower into two portions – the sustainable portion which would be based on the debt servicing capability of the borrower company (classified as a Standard Asset), and the unsustainable portion which would be linked to equity or quasi equity instruments. An Overseeing Committee would be set up by the Banks’ Association, in consultation with the RBI which will review the process and act as an advisory body.

The positive aspects of S4A over the SDR are several, some of which are:

1.         Banks do not have to find a new promoter to buy their stake in the stressed company and the existing promoters are allowed to continue. This acts as an incentive to the promoters to turn the company around and consequently the banks can benefit out of such equity valuation.

2.         Banks are permitted to hold optionally convertible debentures instead of equity shares in the company, which is always more preferable.

3.         The entire debt portion does not have to be converted into equity, as under the SDR scheme. Since only the unsustainable portion of the debt is required to be converted into equity, some bankers are of the opinion that operations will be able to be managed more smoothly and there would be a more realistic chance at recovery of the loan.

However, here are some glaring problems with this scheme that may question its viability:

1.         The S4A does not allow banks to offer any moratorium on debt repayment and also does not allow amendments to the repayment schedule or even a reduction of interest rate.

2.         Unlike under the SDR, there is no relaxation to banks in respect of the provisioning requirement. Therefore, banks will be required to maintain a minimum 20% provision of the total loan amount outstanding or 40% of the unsustainable portion of the debt at the time of initiation of the scheme. The banks will also have to provide for 100% of the expected losses on the unsustainable portion over the period of four quarters, over and above the 20%-40% requirement.[5]

3.         Only projects that have started commercial production can take advantage of this scheme.[6] Therefore, infrastructure projects that may have been stalled due to delay in regulatory approval cannot be invoked under this scheme.

4.         The presumption that conversion of debt into equity is the cure for all ills has not proven to be true in a lot of cases. Equity is a perennial liability and is a costlier mode of finance compared to debt capital which at least has tax benefits. If a project does not seem to be sustainable, this route is not a viable option.

5.         Under the existing framework of the scheme, only the existing cash flows at the current level can be used to determine the debt servicing capability of the company. This mandate received much flak from bankers across the country because they identified that a good number of companies were not operating at their optimal level currently and were therefore unable to make the cut for initiating this scheme.

While the S4A may have theoretically addressed the fallacies that were present in the SDR scheme, the viability of this scheme nonetheless seems questionable to bankers.

- Neelasha Nemani

[1] Sanjay Israni and Rajashree Ravi, India: Strategic Debt Restructuring, Mondaq, October 25, 2016, available at

[2] Explanation: A ‘Standard Asset’ is an asset which is not a Non Performing Asset as defined under section 2(o) of the SARFAESI Act, 2002.

[3] The ‘Provisioning Norms’ referred to here have been detailed in the RBI Master Circular on Prudential Norms on Income Recognition, Asset Classification and Provisioning Pertaining to Advances, 2013.

[4] Interest from a Non Performing Asset is required to be recorded on receipt basis as opposed to interest from a Standard Asset which is recorded on accrual basis. For details, refer to the above Provisioning Norms.

[5] RBI, Notification on Scheme for Sustainable Structuring of Stressed Assets (Guidelines), June 13, 2016.

[6] Id., at para 4.

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