Explained: One-time restructuring of loans, why banks want it, and why RBI is wary

Given the loss of income to organisations and individuals in the wake of the COVID-19 pandemic, the Reserve Bank of India has allowed banks to give their customers a six-month moratorium on outstanding term loans; but banks are not happy with this arrangement. They are requesting the RBI to permit them to restructure the loans.

Here's all you need to know about  restructuring of loans and why the RBI is wary of it.

Restructuring is a practice that allows banks to modify the terms of the loan when the borrower is facing financial stress. Banks do that to avoid the borrower being declared a defaulter and the loan having to be classified as a non-performing asset.

If a loan account is classified as an NPA, then banks will have to set aside money—provisions—towards it. That reduces their profits.

It could be through a change in the repayment period / repayable amount / number of instalments / rate of interest/ additional loans. There could even be ‘compromise settlements’ where time for payment of settlement amount exceeds three months.

With economic activity at a standstill in many parts of the country and things unlikely to improve significantly even after the lockdown lifts,  banks fear another tsunami of bad loans. Many of their retail borrowers will face pay cuts, or worse still, lose jobs. Most corporate borrowers may also be starved of cash as demand for their goods and services have collapsed. This will make it harder for them to repay their loans.

With no visibility on when things may return to normal, banks say they would rather restructure borrowers’ loans in a way that it matches what they can repay. A six-month deferment of the problem is not the solution, say bankers.

Even otherwise, the RBI has mandated banks keep a 10 percent provision for borrowers who have delayed repayments and opted for the moratorium.

So far, the RBI has been non-committal. The regulator’s hesitation is understandable. Memories of the pain from allowing banks to restructure loans are still fresh in its mind. The RBI had announced guidelines for a one-time loan restructuring of loans in 2008, in the aftermath of the global crisis. But the concession was misused by many corporate borrowers and banks, forcing the RBI to tighten the rules in 2015. The regulator now does not want to undo several years’ gains from its NPA clean-up efforts by diving straight back into the very cause for it.

For a long time, banks used the window of regulatory concessions to set aside as little money as possible, for their rotten assets. When it became clear that their clients could not service loans, the terms of the loan were changed to avoid them being tagged defaulters. It was a win-win game. By not being labelled defaulters, promoters could borrow from other banks, and did not have to bring in equity in their struggling projects.

As for banks, less provisions for NPAs meant they could show higher profits and enjoy a better valuation on the stock market.

Often, banks and promoters acted in cahoots to exploit the system this way.

Former RBI Governor Raghuram Rajan went so far as to call it “deceptive accounting” by the banks.

In April 2015, RBI notified new rules which required banks to recognise restructured loans as non-performing assets (NPAs). This also meant more money had to be set aside for these loans. RBI asked banks to provide a minimum of 15 percent of the loan value of the restructured account to cover the risk of default, versus only 5 percent earlier.

To be sure, there is nothing stopping banks from restructuring accounts, provided they first declare them NPAs. This provision is available to them under the overarching framework of the June 7 circular on resolution of bad loans from RBI. However, banks say this will require them to set aside a large chunk of capital which is scarce to come by in these uncertain times.

Banks insist a one-time restructuring without downgrading the loan to NPA will allow them to stitch the repayment plan as per the borrowers’ repayment capacity, while keeping provisioning limited to 5 percent.

As a regulator, RBI’s primary concern is to maintain the financial stability of the economy. This pandemic threatens that. A six month pause on loan repayment may act like a band-aid on a festering wound, but it won’t make the problem go away. Whether it comes in the form of one-time restructuring, or another financial package, a more structural solution is the need of the hour.