RBI’S June 7 Circular: A Relief for stressed borrowers

Authors: Shaivi Shah and Palash Moolchandani, first and second year students respectively, at the National Law University Odisha.

INTRODUCTION

The Feb 12 circular released by the RBI is considered to be one of the then governor, Urjit Patel’s, most controversial policy decisions – and with good reason. In one fell swoop Patel single-handedly struck down existing resolution mechanisms and replaced them with the infamous Feb 12 circular. The Feb 12 circular had its own triumphs and shortcomings, however on 02.04.2019, the Supreme Court declared the conflict ridden circular as unconstitutional. Nearly two months after the landmark judgement, the RBI issued a new circular on 7.06.2019 outlining the revised mechanism to resolve stressed assets.

JUNE 7 CIRCULAR – What’s New?

  1. 30 day review period – Once a default has been committed by the borrower in question, no longer is resorting to IBC mechanism a norm. An additional 30 days have been given to lenders to prima facie review the case of the borrower in question. Within this 30 day period, the lenders may decide on, strategize and implement a resolution plan or label the account as a non-performing asset.[1]
  2. Formulation of ICA made compulsory – When the borrower has more than one lender, the creation of an inter-creditor agreement is now compulsory. The lenders are now required to come together and enter into an ICA in order to determine the procedure, rules and implementation mechanism of the resolution plan. Thus, all lenders with a legitimate interest in the matter have a say in the resolution plan.
  3. Applicability to a larger group of lenders – While the Feb 12 circular was restricted to Banks and All-India Financial Institutions, as per the new circular, the group of lenders has been expanded to include non-banking financial institutions and small companies to ensure that the maximum number of entities can avail the remedy provided by the IBC.
  4. Early formulation of Resolution Plan – Lenders keep a tab on the financial activities of their borrowers and thus tend to know which of their debtors is going to default. A default is only a lagging reaction to an already existent financial crisis. Thus, the new guidelines empower lenders to initiate the formulation of a resolution plan as soon as they believe a default may occur, even before its occurrence.[2]

How is the June 7 Circular Different from the Feb 12 Circular?

  1. Greater Autonomy to Lenders – Previously, lenders were compelled to impose IBC proceedings on defaulters. There was no room to explore alternative options. However, the June 7 circular gives autonomy to lenders to decide what kind of remedy they want to avail. Litigation comes with its own expenses, worries and hassles and this change prevents it from being forced upon the lenders.
  2. Lesser Majority – Earlier, the rule was that 100% of the lenders of the ICA had to give their assent to the resolution plan drawn up before it could be implemented. This feature caused such delays that even if the default could be remedied with the help of a resolution plan, it couldn’t be implemented due to paucity of time in getting 100% assent from all lenders of the ICA. The June 7 circular relaxed this rule and calls for the assent of 75% in value and 60% in number of the creditors to give their assent to the resolution plan before it can be implemented.[3]
  3. RBI’s Discretion Clause – While the June 7 circular doesn’t enforce the IBC proceedings on the lenders, it does include a reference to section 35AA of the Banking Regulation Act, 1949 which enables the RBI to exercise its discretion in initiating insolvency proceedings for borrowers in specific cases.
  4. IBC as a Last Resort – The earlier system was that if the resolution plan was unable to be implemented within the 180 day period, the case must go into insolvency. As per the new circular, post the 30 day review period and the 180 day period that follows, i.e., 210 days from the date of default, if the bank is unable to implement a resolution plan, they must set aside an additional 20% of their profits as provisions for bad debts. If the resolution plan is unable to be implemented within 365 days from the date of default, they will have to set aside an additional 15%. This was implemented mainly to act as a deterrent to banks from delaying the process of implementation of a resolution plan. If it goes to the IBC for resolution, then half the additional provisions may be reversed on filing of the insolvency application. Further provisions may be reversed upon admission of the borrower into insolvency.

Analysis : June 7 Circular a Mixed Bag.

Pros

  1. Lenders now have more autonomy in deciding the manner of resolution. It is voluntary for lenders to avail the IBC proceedings or to follow their own resolution plan as customised by them to cater to their circumstances.
  2. The RBI made the signing of the ICA compulsory within 30 days of the initiation of the resolution plan. The delay that earlier used to take place due to the lenders being unable to come to an agreement can now be avoided. Further, the lower threshold will lead to faster implementation of resolution plans.
  3. In order to avoid the additional higher provisioning, banks will try and stick to the timeframe provided within the IBC, thus fulfilling the main objective of the IBC which is to provide maximum value to creditors by preventing erosion of assets.
  4. Prashant Kumar, CFO at State Bank of India said, “Small lenders would always try to get the full value of the loan even if their exposure was just a few crores. This was not always possible and would delay the process.” The reduced creditor threshold of 75% in value prevents small banks with lesser exposure from holding up the resolution process.
  5. While the earlier requirement for upgradation of the status of an account from ‘non-performing’ to ‘standard’ was a recovery of 20% of outstanding loans, the requirement has now been reduced to 10%. However, the eligibility for accounts to be upgraded will be based on investment grade ratings by external agencies. Thus, the percentage of stressed assets in the country will decrease and the economy will be positively impacted.

Cons

  1. The ICA could potentially be used as an instrument whereby the lenders with the maximum exposure could manipulate both, the borrowers as well as the lenders. The said lenders may refuse to sign the agreement unless they are absolutely satisfied with it, thereby putting the borrowers at risk of being labelled an NPA for a longer amount of time. The other lenders face the risk of having to make additional provisions.
  2. While the reduced creditor threshold would help to hasten the resolution process, the plight of small banks has not been considered. Having low exposure, they are at the risk of not having their interests considered and possibly having to sell their stake at liquidation value.
  3. The additional provisions of 20% and 15% to be implemented in case of failure to implement resolution plan within the time frame provided will be rough on banks considering the capital-deficit nature of the contemporary financial scenario.
  4. The addition of NBFCs is not in their best interest. In a situation where a borrower has not defaulted in his repayment to an NBFC but has done so with another bank/financial institution, the NBFC will be compelled to sign the ICA. Having lesser exposure, their circumstances would be akin to those of small banks as mentioned above.[4]
  5. The Feb 12 circular was struck down because it failed to address sector-specific grievances. The sector-specific issues faced by power companies which were out of their control ultimately forced them to come together in the case which lead to the demise of the Feb 12 circular. While the current circular provides autonomy for lenders via the freedom to create their own resolution plans, no concrete steps have been taken with regard to addressing sector specific issues.

Conclusion

On the whole, the revised circular is a welcome move and a push in the right direction. It provides a good balance between ensuring that the essential objective of the IBC, i.e., faster resolution to prevent value erosion of assets, is not compromised upon and diluting the previous circular to ensure that borrower interests are also taken into consideration. Greater autonomy has been given to lenders and the overall austere nature of the previous circular has been relaxed. Having said that, it is pertinent to note that clarity remains to be achieved on a few issues such as the ICA, forms of disclosure to be made by the lenders, etc. Overall, while the practical applicability of the June 7 circular remains to be seen, it can certainly be considered a much required step toward ensuring that the momentum towards effective resolution remains uncompromised.


[1] George Mathew, One day to One Month for NPA tag : RBI eases norms for debt resolution, The Indian Express (Jun. 8,2019, 6.39 AM), https://indianexpress.com/article/business/banking-and-finance/1-day-to-1-month-for-npa-tag-rbi-eases-norms-for-debt-resolution-5770414/.

[2] Shayan Gosh and Gopika Gopakumar, RBI relaxes stressed assets norms, livemint (Jun. 8, 2019, 12.36 AM), https://www.livemint.com/industry/banking/rbi-relaxes-stressed-asset-norms-1559934009703.html.

[3] Vishwanath Nair, RBI eases Stressed Assets Rules in Review of Feb. 12 Circular, Bloomberg Quint (Jun. 7, 2019, 11.59 PM), https://www.bloombergquint.com/economy-finance/rbi-eases-stressed-asset-rules-in-review-of-feb12-circular.

[4] Gopika Gopakumar, New RBI Debt restructuring rules may hit NBFCs’ Profits, livemint (Jun. 12, 2019, 11.48 PM), https://www.livemint.com/politics/policy/new-rbi-debt-restructuring-rules-may-hit-nbfcs-profits-1560363092717.html.[4] Gopika Gopakumar, New RBI Debt restructuring rules may hit NBFCs’ Profits, livemint (Jun. 12, 2019, 11.48 PM), https://www.livemint.com/politics/policy/new-rbi-debt-restructuring-rules-may-hit-nbfcs-profits-1560363092717.html.

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