Loan Moratorium To Restructuring: Are We Moving In The Right Direction?

Keeping in mind the Covid-19 induced slowdown, the Reserve Bank of India (RBI) came up with the provision of loan moratorium from March 2020, and after an extension, the moratorium ceased to exist as on 31 August 2020.

Moratorium can be defined as a momentary deferment of payment of interest or principal. It does not tantamount to a loan write-off. In layman terms, it can be termed as a loan holiday.

Moratorium relieves an individual or corporate entity from the immediate pressure of shelling out regular EMIs which are then transported to the later part of the loan tenure along with accrued interest on the unpaid EMIs during the holidays.

The concept of just shifting or transporting the EMI burden has made mockery of the otherwise good scheme as there is a need to pay interest on the interest which was unpaid. This arrangement typically hurts borrowers with longer loan tenures as they will have a huge chunk of payments going towards interest and hence, it becomes a double whammy, reducing the usage of the scheme to only those who are in dire need and excluding the otherwise genuine and honest borrowers.

To protect the interest of genuine and honest borrowers, the Supreme Court ordered extension of the loan moratorium until 28 September 2020, and has intimated the Ministry of Finance and RBI to come up with concrete solutions.

Granting EMI relief will directly hit the Centre as majority assets are held by state-owned banks. It is also prudent to add that the number of depositors outnumbers the borrowers, so it won't be a wise decision to ask the depositors to take a hit and further jeopardise the financial stability of the ailing economy.

To tide over these difficult times of liquidity crunch, the instrument of loan restructuring is also available for the lenders. The essential difference between moratorium and loan restructuring is akin to the difference between the effectiveness of painkiller and an antibiotic; restructuring being the antibiotic.

Moratorium was available for all, but restructuring had restricted access. Restructuring is a win-win situation for both the borrowers and the lenders and hence easier to adopt and use. Knowing its importance and long term effects, RBI was swift to announce extension of moratorium in the form of restructuring.

Loan restructuring is a process which allows the firm (entity) or individual facing cash flow problems or financial distress to reduce and renegotiate its debt to improve or restore liquidity enabling continuity in operations. The rider being that the loan must be classified as standard and must not be in default for more than 30 days as on 1 March 2020.

The universe of loans to be restructured covers everything from personal, home, gold, education and car loans. Submission of documentary evidence is mandatory to avail these benefits. To avoid misuse and collusion, RBI has ensured that this remains a one-time exercise.

The decision on usage has to be taken before the end of this calendar year and this classification has to be initiated within 180 days from the date of invocation.

There is no doubt that restructuring rewards honest borrowers (as determined by their credit history).

However, the million-dollar question is whether restructuring would be successful in meeting its desired objectives.

The vanilla textbook advantage of restructuring to banks is that it avoids bankruptcy and hence less provisioning is required for these loans than otherwise, had they turned into non-performing assets (NPAs).

The K V Kamath Committee appointed by RBI has laid down clear key indicators and guidelines to be followed by the lenders while restructuring the loans.

About Rs 15.5 trillion of loans is expected to be restructured in addition to the Rs 22.2 trillion from the pre-Covid-19 era which is already in the queue.

The committee has identified major sectors like retail and wholesale trade, hospitality, textiles, tourism, aviation and shipping, which are in acute stress. It is imperative to bail out these sectors to avoid spillovers to other healthy sectors of the economy.

The committee has also identified five key financial ratios; to name a few, current ratio, debt service ratio, total debt etc as benchmarks in deciding upon the restructuring terms and conditions.

However, the question arises, is it not much easier to let the lenders decide the terms of restructuring with their borrowers? Is micro-managing of loan restructuring a prudent step at this stage? It is possible that because of the rigid ratios and guidelines, some genuine and honest borrowers may not make the cut.

Since Covid-19 has had a differential impact on various sectors, lenders and borrowers should be given the freedom to assess the ground reality and mutually decide the terms of restructuring.

The answer lies down memory lane and in the lessons we learnt from loan restructuring during the global financial crisis of 2008.

Most of the restructured loans ultimately slipped into NPAs and there were massive allegations of misuse and siphoning of the loan funds to foreign locations. Though some believe that restructuring reflects badly on the balance sheets of the borrowers as the term ‘restructured’ worsens their credit score and hurts their chances of availing future credit, there is a good reason to exercise caution.

There has been a tendency to borrow from small lenders and shadow banks without much documentation by creating securities and corporate guarantees, which otherwise would not be cleared at the big banks.

There is inevitable increase in frauds and defaults in times of crisis. As per RBI’s Annual Report 2020, a whopping Rs 1.85 trillion has been lost to fraud by the borrowers, for which 100 per cent provisioning is mandated as per existing guidelines. All these arguments necessitate the existence of a broad framework in the form of the Kamath Committee guidelines for restructuring.

The pace of recovery for the economy holds the key to getting the desired outcomes from the restructuring. There is no doubt that lenders will have to walk the tight rope and yet success may not entirely depend on their actions; it will be dictated by the prudent usage of resources by the borrowers.

The economy is expected to continue contracting, but restructuring can help build resilience in it, and which will be beneficial in the long run. The economy is certainly fortunate to have the Insolvency and Bankruptcy Code in place which will also certainly aid in avoiding the misuse of debt restructuring and help the stakeholders learn from the mistakes of the past. Let’s all hope that the worst is behind us and the economy has hit its trough.

Ashish Shinde is an officer of the Indian Economic Service and a public policy graduate from the University of Chicago. Views expressed are personal.