‘Restore sanctity of the debt contract’

The revised framework for resolution of stressed assets is aimed at restoring the sanctity of the debt contract embedded in bank loans, which has been continuously losing its sanctity, according to NS Vishwanathan, Deputy Governor, Reserve Bank of India.

The revised framework tries to reduce the arbitrage the borrowers are currently enjoying while raising funds through borrowing from banks vis-à-vis raising funds from the capital markets, he added.

“If a borrower delays coupon/principal payment on a corporate bond even for one day, the market would penalise the borrower heavily – the rating would be downgraded, the yields on the bonds would shoot up, cost of further financing would increase and suits would be filed by investors, to name a few.

“So far, defaults in bank borrowings have not attracted similar reaction,” said Vishwanathan.

He elaborated that only when the overdues stretch beyond 90 days, the loans would be classified as non-performing assets. Hence, efforts by lenders and borrowers have been to avoid the account having to be de jure classified as NPA, notwithstanding the de facto status.

“What this means is that the debt contract embedded in bank loans in India has been continuously losing its sanctity, especially where the borrowing is large. There is a need to change this and restore the sanctity of the debt contract, lest bank debt becomes subordinate even to equity. The new framework is precisely aimed at doing this,” said Vishwanathan.

Prompt repayment

He emphasised that prompt repayment to banks is critical because they access unlimited uncollateralised funding from among others, the common persons, on the strength of the banking licence.

The Reserve Bank believes that a focused framework for resolution of distressed borrowers, which respects and enforces the sanctity of the debt contract, is required to make sure that the excesses observed during the last credit cycle are not repeated, and that “we don’t end up in a similar situation few years down the line”.

On concerns expressed in some quarters that the one-day default clause is onerous, Vishwanathan said: “These concerns are not well founded. Let me tell you why. For cash credit account, the 30-day trigger has been retained.

“For term loans, where the repayment schedules are predetermined, borrowers need to and indeed have enough notice to arrange funds in time. It is a behaviour change in repayment of credit that has to come about.”

Based on the first few reports received from banks under the new reporting system, the top RBI official said non-payment on due date appears to be seen as par for the course by the banks and borrowers.

“The data shows that a large number of borrowers, even some highly rated ones, have failed on the one-day default norm. This has got to change.

“If borrowers fail to pay on the due date because of a cash flow problem, banks should see that as an early warning indicator warranting immediate action. If borrowers, with the ability to pay on the due date, delay it routinely or because they see other arbitrage options, that must change, too,” explained Vishwanathan.

Bankers should warn their customers that one-day default will lead to their being on watch for resolution, he said, and added that borrowers, too, should realise that they have to meet payment obligations as per the contract and it is no more sufficient to pay up only by 60/90 days past due date.

“I want to mention here that for the small borrower who may not have the wherewithal to bring funds swiftly in the event of non-payment by clients, the framework makes an exception.

“The framework for restructuring has been consciously made non-applicable to the Micro, Small and Medium Enterprises (MSMEs) with borrowings of ₹25 crore and less. We have left their resolution framework unchanged from what was outlined for them in March 2016,” the Deputy Governor said.

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