Report of the Working Group to review the existing guidelines on restructuring of advances and align them with the guidelines on CDR Mechanism - ਆਰਬੀਆਈ - Reserve Bank of India
Report of the Working Group to review the existing guidelines on restructuring of advances and align them with the guidelines on CDR Mechanism
Department of Banking Operations and Developmen Reserve Bank of India Mumbai Contents
Executive Summary 1. In the Annual Policy Statement for the Year 2006-07, it was proposed that a Working Group will be constituted to review and align the existing guidelines on restructuring of advances (other than under CDR mechanism) on the lines of provisions under the revised CDR mechanism. Accordingly, in order to review and align the existing guidelines on restructuring of advances (other than under CDR mechanism) on the lines of provisions under the revised CDR mechanism, a Working Group comprising members from commercial banks, Indian Banks' Association (IBA), Department of banking Operations and Development (DBOD) and Department of Banking Supervision (DBS) of RBI was constituted.2. The Group studied the existing RBI guidelines on restructuring of advances under CDR Mechanism, under SME debt restructuring Mechanism, guidelines applicable to advances to other industrial borrowers not covered under CDR/SME debt restructuring mechanisms and the borrowers in the non-industrial sectors. The Group observed that there exist significant differences in the guidelines relating to restructuring of these distinctive categories. The Group identified the following issues from the existing position: a) Whether the prudential norms and regulatory concessions prescribed under CDR Mechanism should be extended to other categories of advances also? b) If so, what should be the framework? Whether different sets of prudential norms and concessions need to be applied to different categories of advances? 3. Based on the analysis carried out( Chapter 4), the Group arrived at mainly two broad conclusions. First, the regulatory framework prescribed under CDR Mechanism is very exhaustive and is conceptually sound. Therefore, it should be the basis of restructuring framework for all other advances. Second, while the basic prudential framework for all advances would be the same, some modifications would be required for different categories of advances. The difference could be mainly in the applicability of the prudential norms and the manner in which the diminution in the value of the loan is computed and provided for. 4. The advances extended to traders differ from the advances for production purposes in as much as the reasons for cash flow problems such as cost escalation, delay in project in implementation, change in working capital cycles, problems in procuring the raw material and retention of the market share of the product are not relevant for these advances. Similarly, the retail loans including housing loans are also different inasmuch as they do not depend upon the repayment from the productivity of the asset, which has been financed by the bank. Therefore, the terms for restructuring of the advances for traders, retail loans including housing loans should be relatively more stringent. Further, RBI need not prescribe detailed parameters for restructuring of these advances and may issue only very broad guidelines. i) Borrowers engaged in industrial activities and not covered under CDR/SME debt restructuring mechanisms and the borrowers in agricultural and services sector having single bank arrangements but above Rs. One crore. 6. The Group has suggested certain changes in the prudential norms applicable to restructured advances, in addition to those effected under CDR Mechanism. These changes, which are mostly in the nature of clarifications to the existing instructions, would need to be applied to advances restructured under CDR mechanism/SME Debt restructuring also. 7. The Group has excluded from its purview the restructuring of advances in case of natural calamities. The restructuring of advances of the borrowers who suffer from natural calamities will be done as per separate set of guidelines issued by RPCD from time to time. The Group does not propose any change in this regard. Chapter 1 Introduction The Reserve Bank of India (RBI) had issued guidelines in March 2001 allowing banks/financial institutions to restructure/reschedule credit facilities extended to industrial units which are fully secured by tangible assets, subject to certain conditions. In August 2001, an institutional mechanism for restructuring of corporate debt in the form of the Corporate Debt Restructuring (CDR) system was put in place. The CDR mechanism, which was reviewed twice in 2003 and 2005, covers multiple banking accounts/syndication/consortium accounts with outstanding exposure of Rs.10 crore and above by banks and institutions. Besides, in September 2005, the Reserve Bank issued guidelines for restructuring of debt of all eligible Small and Medium Enterprises (SME). These guidelines encompass (a) all non-corporate SMEs irrespective of the level of dues to banks. (b) All corporate SMEs, which are enjoying banking facilities from a single bank, irrespective of the level of dues to the bank. (c ) All corporate SMEs, which have funded and non-funded outstanding up to Rs.10 crore under multiple/ consortium banking arrangement 1.3. Accordingly, in order to review and align the existing guidelines on restructuring of advances (other than under CDR mechanism) on the lines of provisions under the revised CDR mechanism, a Working Group comprising members from commercial banks, Indian Banks' Association (IBA), Department of banking Operations and Development (DBOD) and Department of Banking Supervision (DBS) of RBI was constituted. The members are (i) Shri Prashant Saran Chairman (ii) Shri T R Bajalia Member (iii) Shri G Sankaranarayanan Member (iv) Shri Ajai Singh Member (v) Shri K Gopalakrishnan, Member (vi) Shri P R Ravi Mohan Member Secretary Extant guidelines on Corporate Debt Restructuring and Debt Restructuring Mechanism for Small and Medium Enterprises (SMEs) and other accounts A comparison of the salient features of the various types of restructuring mechanisms is attempted in this chapter with the primary objective of identifying the gaps existing in the restructuring of accounts other than the CDR mechanism and SME accounts. This would facilitate the formulation of guidelines in tandem with the extant norms for restructuring under CDR mechanism to such accounts as per the terms of reference for the group. The comparisons have been attempted under the parameters viz., Coverage of guidelines, Additional finance, One-time settlement, Restructuring of doubtful debts & Prudential norms. 2.1. Coverage of guidelines 2.1.2. SME Debt Restructuring 2.2 Additional Finance 2.2.2 SME Debt Restructuring 2.3. One time settlement as part of restructuring package 2.3.3 General Guidelines for restructuring of accounts of industrial borrowers other than those covered above 2.4.1 CDR Mechanism Doubtful accounts are eligible to be restructured under CDR mechanism and are thus entitled to concession in the asset classification norms. 2.4.2 SMEs Treatment of ‘standard’ accounts restructured under CDR A. A rescheduling of the installments of principal alone, at any of the aforesaid first two stages would not cause a standard asset to be classified in the sub-standard category and reschedulement of installments of principal at the third stage refer to above would not cause sub-standard / doubtful asset to slip further down in the asset classification categories, provided the following conditions are satisfied. i) Advance is fully securedii) The restructuring conforms to the following parameters: a) Restructuring under CDR mechanism is done for the first time, ii) The restructuring conforms to the following parameters: a) Restructuring under CDR mechanism is done for the first time, b) The unit becomes viable in 7 years and the repayment period for the restructured debts does not exceed 10 years, c) Promoters’ sacrifice and additional funds brought by them should be a minimum of 15% of creditors’ sacrifice, and d) Personal guarantee is offered by the promoter except when the unit is affected by external factors pertaining to the economy and industry. (iii) The moratorium period for interest payments fixed under restructuring C. A rescheduling of interest element would render a sub-standard / ‘doubtful’ asset eligible to be continued to be classified in sub-standard / ‘doubtful’ category for the specified period, i.e., a period of one year after the date when first payment of interest or of principal, whichever is earlier, falls due under the rescheduled terms. The account can be upgraded after one year of satisfactory performance as indicated herein. 2.5.1.2 SMEs debt restructuring 2.5.1.3 Industrial borrowers other than CDR and SMEs borrowers ii) The conditions enumerated at para 2.5.1.1(A)(ii) & B(ii) and (iii) are not applicable to such accounts. 2.5.1.4 Non-industrial borrowers While banks may consider accounts other than that of industrial units also for restructuring, such accounts would have to qualify the basic test of viability before it is considered for restructuring. However, these accounts would not qualify for the special asset classification status available to restructured ‘standard’ and restructured ‘substandard’/Doubtful accounts as indicated in paras 2.5.1.1 above. The accounts which do not qualify for restructuring/ rescheduling in terms of para 5.1.1above, will be subjected to the following prudential norms.i) These restructured/ rescheduled accounts would continue to age and migrate to the next asset classification status in the normal course. Banks should ensure that the amount of sacrifice, if any, in the element of interest - both in term loans or working capital facilities, measured in present value terms, is either written off or provision is made to the extent of the sacrifice involved. For the purpose, the future interest due as per the original loan agreement in respect of an account should be discounted to the present value at a rate appropriate to the risk category of the borrower (i.e., current PLR + the appropriate credit risk premium for the borrower-category) and compared with the present value of the dues expected to be received under the restructuring package, discounted on the same basis. ii) These restructured/ rescheduled accounts, whether in respect of principal instalment or interest amount, by whatever modality, would be eligible to be upgraded to the standard category only after a period of one year after the date when first payment of interest or of principal, whichever is earlier, falls due under the revised terms, subject to satisfactory performance during the period. The amount of provision made earlier, net of the amount provided for the sacrifice in the interest amount in present value terms as aforesaid, could also be reversed after the one year period. 2.5.2 Annual review of provisions If the conversion of interest into equity, which is quoted, interest income can be recognized after the account is upgraded to the standard category at market value of equity, on the date of such up gradation, not exceeding the amount of interest converted into equity. If the conversion of interest is into equity, which is not quoted, interest income should not be recognized. 2.5.3.3 Industrial borrowers other than CDR and SMEs 2.5.4.4 Non- industrial borrowers 2.5.6 Linkage of regulatory concessions with the timely disposal of applications/implementation of packages 2.5.6.1 CDR Mechanism 2.6. Viability benchmarks 2.7.3 Industrial borrowers other than CDR and SMEs 2.8.1 CDR mechanism 2.8.2 SMEs debt restructuring In regard to accounts with single bank, the individual banks would deal with the restructuring in the following manner: a) The restructuring would follow a receipt of a request to that effect from the borrowing units.b) In case of eligible SMEs which are under consortium/multiple banking arrangements, the bank with the maximum outstanding may work out the restructuring package, along with the bank having the second largest share. 2.8.3 Industrial borrowers other than CDR and SMEs 2.8.4 Non-industrial borrowers 2.9. Disclosures Disclosure in the form prescribed by RBI are required to be made. 2.9.2 SMEs debt restructuring Same as para 2.9.1. 2.9.3 Industrial borrowers other than CDR and SMEs Same as para 2.9.1 2.9.4 Non-industrial borrowers Same as para 2.9.1 Chapter 3 International practices relating to restructuring of loan accounts International practices relating to restructuring of loan accounts particularly that regarding the prudential norms applicable to such accounts were studied. However, not much material could be collected on all the aspects of restructuring presently covered under the CDR mechanism. A brief account of practices observed in respect of a few parameters is given hereunder: 3.1 Definition of Restructured Facility Australia
(b) an interest rate below the terms originally contracted; (c) a reduction of accrued interest, including forgiveness of interest; (d) a deferral or extension of interest or principal payments, including interest capitalisation; (e) an extension of the maturity date or dates at a stated interest rate lower than the current market rate for new facilities with a similar risk; or (f) an extension of the maturity date or dates materially beyond the maturities that would be offered to new facilities with similar risk. Singapore A credit facility is restructured when a bank grants concessions to a borrower because of a deterioration in the financial position of the borrower or the inability of the borrower to meet the original repayment schedule. The revised repayment terms relating to the interest or repayment period, are normally considered as non-commercial by a bank. 3.2 Computation of diminution in the fair value of the loan consequent upon restructuring Australia Thailand 3.3 Classification of restructured Assets Australia Hong Kong Singapore Thailand 3.4. Upgradation of restructured facilities HongkongThe restructured loans may be upgraded to pass once they have been serviced according to the revised terms for six months in the case of monthly repayments or 12 months in the case of quarterly or six-monthly repayments. Australia Singapore A bank may restore a classified credit facility to unclassified status only when, in the case of a restructured credit facility, there are reasonable grounds for the bank to conclude that the borrower will be able to service all future principal and interest payments on the credit facility in accordance with the restructured terms. Chapter 4
b) If so, what should be the framework? Whether different sets of prudential norms and concessions need to be applied for different categories of advances? The Group’s views on the above issues are indicated below: 4.1.3 Extension of asset classification concession to doubtful accounts of other category of advances Doubtful accounts restructured under CDR mechanism/ SME Debt Restructuring are eligible for asset classification concession indicated in para 5.1.1 of Chapter 2. However, doubtful accounts belonging to other categories of advances are not eligible for such concessions, even though the banks are expected to make provision for any sacrifice in the element of interest. The Group is of the view that this provision should be extended to advances to agricultural and services sector also. 4.1.4 Prudential norms A. Asset classification and provisioning norms for restructured advances (I) In the matter of computation of provision in lieu of sacrifice in the element of interest consequent of restructuring of advances there are two major issues as indicated below: (i) Whether the sacrifice is to be computed with reference to the original rate of interest or the market related interest represented by the current BPLR as on the date of restructuring plus the appropriate term premium and credit risk premium for the borrower category on the date of restructuring. ii) As the guidelines do not speak about computing the sacrifice (in terms of opportunity loss incurred) made by banks by elongation of the repayment period of principal, there is an impression that the guidelines require the banks to make provision for the sacrifice in the element of interest alone and there is no focus on computing the diminution fair value of the entire loan, which is an internationally accepted practice. Original versus market related rate of interest Under CDR / SME debt restructuring mechanism, the sacrifice in the element of interest is computed as the difference in the present value of notional interest income based on current BPLR as on the date of restructuring plus the appropriate term premium and credit risk premium for the borrower category on the date of restructuring and the interest income reckoned based on the rate of interest fixed under the terms of restructuring. In other cases, it is computed as the difference in the present value of notional interest income based on the current BPLR as per the original terms of the loan and the interest income reckoned based on the rate of interest fixed under the terms of restructuring. The discount rate used in both the cases is the current BPLR as on the date of restructuring plus the appropriate term premium and credit risk premium for the borrower category on the date of restructuring. The use of BPLR + risk premium instead of original rate of interest for computing the notional interest income under CDR mechanism ensures that the computation of sacrifice/ diminution in the value of loan is done with reference to the book value of the loan. The Group is, therefore, of the view that the same approach should be followed in all other cases. Diminution in the fair value of the loan versus the sacrifice in interest element alone (a) "The present value of future interest income reckoned based on ‘the current BPLR as on the date of restructuring plus the appropriate term premium and credit risk premium for the borrower category on the date of restructuring’ and as per the revised repayment schedule( the existing repayment schedule if it is not changed) (b) The present value of the interest income reckoned based on the actual interest charged as per the restructuring package and the revised repayment schedule (the existing repayment schedule if it is not changed). It may be stated that existing CDR guidelines issued by RBI are silent on the repayment period of principal to be considered for calculating the interest cash flows represented by stream (a) above. On their own, banks have been taking into account the revised repayment schedule for both the cash flow streams. Incidentally, the procedure followed by banks under CDR Mechanism gives the amount of sacrifice which is equivalent to the diminution in the value of the entire loan with reference to its book value indicating that, knowingly or unknowingly, banks have been providing for the diminution in the value of the entire loan i.e. both interest and principal. Though the procedure followed by the bank under CDR Mechanism is mathematically correct for working out the diminution in the fair value of the loan, it obscures the basis on which it has been arrived at. (Please see Illustration at Annex 1). Guidelines for computation of sacrifice in other cases Existing RBI instructions for computation of sacrifice in the element of interest in non-CDR cases require the banks to compute the difference between the PV of interest cash flows calculated based on original residual repayment schedule applying the original rate of interest and the new repayment schedule applying the new rate of interest. The computation of this value not only lacks any theoretical basis but it also does not serve any purpose. In some cases, where the repayment schedule for principal is elongated beyond a point, the PV of interest as per revised scheduled exceeds the PV of interest as per original schedule despite reduction in rate of interest and results in negative sacrifice in the element of interest despite reduction in rate of interest. (Please see Illustration at Annex 1). II. Suggested framework ( Recommendation No. 5.5.1) ii) For arriving at the diminution in the fair value of the loan consequent upon reduction in the rate of interest, it is necessary to take into account the NPV of both interest and principal cash flows. It is a different matter that in cases where the repayment schedule is not changed, for calculating the diminution in the fair value of the loan, it is sufficient to compute the sacrifice in the element of interest cash flows alone because the PV of principal will remain the same in both the scenarios and will get cancelled out. However, in the cases where the repayment schedule is changed, the cash flows representing repayment of principal should also be taken into account for the purpose of computation of diminution in the value of the loan, because PV of the principal as per revised repayment schedule could be less than the PV of the principal cash flows as per the revised repayment schedule. iii) Summarily, the Group suggests that, irrespective of whether the repayment schedule is changed or not, banks should work out the diminution in the value of the entire loan, and not just the sacrifice in the element of interest, as the difference in the PV of the following two cash streams: a) The present value of future interest income based on ‘the current BPLR as on the date of restructuring plus the appropriate term premium and credit risk premium for the borrower category on the date of restructuring’ and of the installments of principal, as per the original (residual) repayment schedule. (As this cash stream is equal to the book value of the loan, no calculation are required to be made and the book value can be directly taken as the PV of cash stream (a).) b) The present value of future interest income based on the actual interest charged as per the restructuring package and of the installments of principal as per the revised repayment schedule (the original (residual) repayment schedule if not changed) For the purpose of calculation of the present value as indicated above, the discount rate used will be the current BPLR as on the date of restructuring plus appropriate term premium and credit risk premium as on that date. iv) In the case of borrowers in agricultural and services sector as also in the industrial sector, with outstanding facilities below Rs. 1 crore, in order to make it easier for small branches and uncomputerised branches in the rural areas having scarcity of skilled staff to restructure the loans and hold provision for sacrifice, the current asset classification status of the account can be retained in the event of reschedulement of principal/interest or both, provided the following two conditions are complied with: a) The advance is fully securedb) The bank makes a provision at aggregate level equivalent to 5% of total advances restructured under this mechanism in lieu of diminution is fair value of the loan, if any, without computing it in terms of PV. ( Recommendation No. 5.1.3) v) In the case of accounts classified as 'Doubtful', the provision in lieu of sacrifice/diminution in the fair value of the loan( but excluding any provisions in the nature of reversal of unrealized income), may be restricted to the difference between the book value of the loan and the existing provision held. In other words, the total provision need not exceed 100% of the book value of the loan. ( Recommendation No. 5.5.1 (ii) ) B. Annual review of provisions Under CDR mechanism, the sacrifice is re-computed on each balance sheet date till satisfactory completion of all repayment obligations and full repayment of the outstanding in the account, so as to capture the changes in the fair value on account of changes in BPLR, term premium and the credit category of the borrower. Consequently, banks may provide for the shortfall in provision or reverse the amount of excess provision held in the distinct account. The same treatment may be extended to other advances also where provisions for sacrifice is made. C. Prudential norms on conversion of unpaid interest into equity ( Recommendation No. 5.5.2) i) Under CDR mechanism where overdue interest is funded or outstanding principal and interest components are converted into equity, debentures, zero coupon bonds or other instruments and income is recognized in consequence, full provision is required to be made for the amount of income so recognized.ii) Equity, debentures and other financial instruments acquired by way of conversion of outstanding principal and / or interest should be classified in the AFS category and valued in accordance with the extant instructions on valuation of banks’ investment portfolio except to the extent that (a) equity may be valued as per market value, if quoted (b) in cases where equity is not quoted, valuation may be at break-up value in respect of standard assets and in respect of sub-standard / doubtful assets, equity may be initially valued at Re1 and at break-up value after restoration / up gradation to standard category. iii) If the conversion of interest into equity, which is quoted, interest income can be recognized after the account is upgraded to the standard category at market value of equity, on the date of such up gradation, not exceeding the amount of interest converted into equity. If the conversion of interest is into equity, which is not quoted, interest income should not be recognized. iv) In case of conversion of principal and / or interest into equity, debentures, bonds, etc., such instruments should be treated as NPA ab-initio in the same asset classification category as the loan if the loan’s classification is substandard or doubtful on implementation of the restructuring package and provision should be made as per the norms. Consequently, income should be recognized on these instruments only on realization basis. The income in respect of unrealised interest which is converted into debentures or any fixed maturity instruments, would be recognized only on redemption of such instruments. v) Banks may reverse the provisions made towards income recognised at the time of conversion of accrued interest into equity, bonds, debentures etc. when the instrument goes out of balance sheet on sale / realisation of value / maturity. It is observed that the conversion into equity takes place both in respect of interest and principal. In the case of equity created in lieu of interest, there are two ways in which the unrealized income can be provided for. One way is to treat the transaction as if the interest income was received, accounted for and the funds utilized to purchase equity. Any diminution in the value of equity subsequently can be taken care of by subjecting the equity to usual valuation as per existing norms. Another way to treat the transaction is to treat the equity a worthless receivable and make 100% provision against it. This would in a way reverse the credit to P&L Account which was effected while creating the equity. In that case there would be no need for any valuation. In view of the above, our instructions that the equity created in lieu of interest should be valued as per market value and at the same time the banks should hold 100% provisions against it/the income recognized would result in double provisioning for the same instrument. There cannot be two debits to P&L Account (provision and depreciation) to set off the one credit which was made to it. Therefore, the Group is of the view that in the case of equity created by conversion of overdue interest, full provision should be held. Any diminution in the value of such equity subsequently should be adjusted against the provision held. The interest income may be finally recognized on cash sale of the instrument, equivalent to the sale proceeds. Any amount realized in excess of the original value of equity may be accounted for as profit on sale of investments. D. Applicability of capital market exposure norms to equity created by conversion of debt/overdue interest ( Recommendation No. 5.6) Under CDR mechanism equity acquired by way of conversion of debt / overdue interest under the CDR mechanism is allowed to be taken up without seeking prior approval from RBI, even if by such acquisition the prudential capital market exposure limit prescribed by the RBI is breached, subject to reporting such holdings to RBI, Department of Banking Supervision (DBS), every month along with the regular DSB Return on Asset Quality. However, banks will have to comply with the provisions of Section 19(2) of the Banking Regulation Act 1949. Acquisition of non-SLR securities by way of conversion of debt is exempted from the mandatory rating requirement and the prudential limit on investment in unlisted non-SLR securities prescribed by the RBI, subject to periodical reporting to RBI in the aforesaid DSB return. ( Recommendation No. 5.5.4) Under CDR mechanism the regulatory concessions in asset classification are not available if the account is restructured for the second or more times. In case a restructured asset, which is a standard asset on restructuring, is subjected to restructuring on a subsequent occasion, it should be classified as sub-standard. If the restructured asset is a sub-standard or a doubtful asset and is subjected to restructuring, on a subsequent occasion its asset classification would be reckoned from the date when it became NPA on the previous occasion. However, such assets restructured for the second or more time may be allowed to be upgraded to standard category after one year from the date of first payment of interest or repayment of principal whichever falls due earlier in terms of the current restructuring package subject to satisfactory performance. In this context, a clarification is needed that all cases involving reschdulement / rephasement should be treated as second restructuring, if such reschdulement/ rephasement results in reduction in the present value of the loan (principal / interest cash flows), irrespective of whether the terminal date is postponed or not. However, if the modification does not result in reduction in the present value of principal / interest cash flows, it need not be treated as a second restructuring, provided the advance continues to be fully secured. ( Recommendation No. 5.1.1.1(II) and 5.1.3 (II) Under CDR Mechanism, if an approved package is not implemented within four months after the date of approval by the Empowered Group, it would indicate that the success of the package is uncertain. In that case, the asset classification status of the account should not be restored to the position as on the date of reference to the CDR Cell. ( Recommendation No. 5.5.3) G.1 Reduction in the rate of interest in the case of first restructuring The following method is suggested to effect such reduction in rate of interest : i) The notional rate for the particular borrower may be determined by adding to existing BPLR the credit risk premium and term premium applicable to the category of the borrower as on the date of reduction of the interest rate.ii) Any reduction in the rate of interest equal to the difference between the fixed rate of interest being charged and the rate of interest determined as indicated in para (i) above may not be treated as a concession and therefore the account not treated as having been restructured. G.2 Reduction in the rate of interest in the case of second restructuring a) Where Interest rate fixed on the restructured loan is linked to BPLR: In case of restructured accounts where interest is linked to BPLR, if the reduction in rate of interest is done only to the extent that the original difference between the spread justified by the rating and the spread actually charged is maintained, it need not be treated as second restructuring. For instance, if the rate justified by the risk rating was BPLR + 5% and the borrower was charged BPLR + 2% after first restructuring, the concession given is 3%. Now suppose the improvement in prospects of the industry to which the unit belongs or in the borrower's financial position results in better credit score for the borrower and the rating improves with the result that the risk premium justified by the rating is reduced to 4%. In that case, the bank may lower the rate to BPLR + 1%, (maintain the level of concession given) and pass on the benefit of improved rating to the borrower. However, to qualify for above treatment, reduction in the rate should be effected through revision in rating of the borrower as suggested above, not independent of it, as this would be necessary to distinguish the reduction justified by improved rating from any arbitrary reduction in the nature of further concession. b) Where rate of interest rate on the restructured loan is fixedIn cases where rate of interest on restructured accounts is fixed, the benefit of reduction in rate of interest without attracting provisions of second restructuring can be passed on to the borrower by notionally converting the fixed rate being charged as per first restructuring into BPLR + risk premium and applying the framework suggested above. H. Impact of changes in non-financial terms of the loan ( Recommendation No. 5.5.5) Any changes in the terms of restructuring which do not result in reduction in the present value of the loan (principal plus interest cash flows) or the advance being rendered partially / fully unsecured need not be treated as restructuring. I. Computation of provision in lieu of sacrifice in element of interest in the case of FITL( Recommendation No. 5.5.6) I.1 FITL created as part of restructuring package As per existing instructions, banks are required to compute provision in lieu of sacrifice in the element of interest in the case of working capital advances also. A sample study carried out by the Department to ascertain the actual practice being followed by various banks in this regard revealed that banks were computing sacrifice in the case of all the three components of a restructured working capital facility viz. Regular working capital portion, WCTL and FITL. I.2. FITL created during the implementation of the project In this context, the Group felt that even though FITL is treated as part of the project cost, treating this as income in the case of NPA Accounts would not be prudent. The facility of booking the income on accrual basis is available only for standard accounts during a brief period of project implementation plus 6 months. However, after the account is upgraded to standard category, there is case for according it the same treatment as would have been accorded had the account continued as a standard asset. Thus, after upgradation, the banks may be allowed to reverse the outstanding provisions against the FITL. There may be cases where the account is restructured as a standard asset and rate of interest on FITL is reduced with or without elongation in the repayment schedule. In such cases, the bank would not be holding any provisions against the FITL. Therefore, the diminution in the fair value of FITL (both principal and interest) should be computed as per usual norms and provision for diminution made. However, in cases where the account is classified as NPA after restructuring, no provision is required for any diminution in the fair value of FITL during the period when account continues to be NPA because FITL during this period is otherwise required to be fully provided for. However, after upgradation of such accounts, the full provision will be reversed( as suggested above), and therefore, the diminution in the fair value of FITL (both principal and interest) should be computed as per usual norms and provision for diminution made. Banks should not fund, through FITL or otherwise, the interest charged beyond the original date of completion of project, even if the borrowers capitalize the interest as per usual accounting norms applicable to them. ( Recommendation No. 5.1 and 5.2) i) For large borrowers above Rs. 1 crore the norms as applicable to CDR mechanism can be applied without any modifications. For small borrowers, provision on aggregate basis as suggested in para 4.1.4 A. (II)(iv), may be made in lieu of the diminution in the value of the loan. ( Recommendation No. 5.1.1.(II) and 5.1.3.II) b) The accounts of the borrowers engaged in agricultural and services sector and having multiple banking/consortium/syndicate arrangements can be restructured under the existing CDR mechanism. iv) Borrowers engaged in agricultural and services sector having multiple banking/consortium/syndicate arrangements v) All borrowers including those in industrial sector with outstanding facilities below Rs. One crore except (iv) below. vi)Trading Accounts/Retail loans including Housing Loans and any unsecured advances irrespective of amount. 4.2.3 The Group has excluded from its purview the restructuring of advances in case of natural calamities. The restructuring of advances of the borrowers who suffer from natural calamities will be done as per separate set of guidelines issued by RPCD from time to time. The Group does not propose any change in this regard. ( Recommendation No. 5.3) 4.2.4 In this Chapter, the Group has suggested certain changes in the prudential norms applicable to restructured advances, in addition to those effected under CDR Mechanism, which are mostly in the nature of clarifications. These changes would need to be applied to advances restructured under CDR mechanism/SME Debt restructuring also. ( Recommendation No. 5.5 and 5.7) 4.3 Disclosures ( Recommendation No. 5.4) The amount of all restructured accounts including the accounts restructured by banks under their own policies should be disclosed along with the amount of provisions held thereagainst in the balance sheet. Chapter 5 Recommendations 5.1 Borrowers engaged in non-trading activities The following norms are suggested for restructuring of accounts of such borrowers: I. The same prudential norms as are applicable under CDR Mechanism should be followed with the modifications indicated in para 5.5. below. II. The applications should be finally disposed of and the packages implemented within 60 days from the receipt of application by the bank. ( para 4.1.4 & 4.2.1 (a)(ii) ) III. The asset classification status of the account as on the date of receipt of the application may be restored if the package is implemented within 60 days from the receipt of the application. IV. If the package is not implemented within 60 days, the asset classification of the account on the date of actual implementation of the package will continue. However, the account will not slip further into lower asset classification categories during the period it is under observation and will be upgraded as per usual norms.(Para 4.1.4. F & 4.2.1 a. (ii) 5.1.2 Borrowers engaged in agricultural and services sector having multiple banking/consortium/syndicate arrangements ( para 4.2.2) The entire CDR framework may be applied to such borrowers enjoying credit facilities above Rs. 10 crore and the SME debt restructuring scheme for all borrowers enjoying credit facilities below Rs. 10 crore. 5.1.3. All borrowers including those in industrial sector ( SMEs) with outstanding facilities below Rs. One crore except those covered in para 5.2 below. ( para 4.1.4 A & 4.2.2) I. All norms applicable to SME borrowers would be applicable, subject to following modifications: The current asset classification status of the account can be retained in the event of re-schedulement of principal/interest or both subject to the following two conditions: III. If the package is not implemented within 60 days, the asset classification of the account on the date of actual implementation of the package will continue. However, the account will not slip further into lower asset classification categories during the period it is under observation and will be upgraded as per usual norms. ( Para 4.1.4.F ¶ 4.2.1(a)(ii) 5.2 Trading Accounts/Retail loans including Housing Loans and any unsecured advances irrespective of amount ( para 4.2.1.c & 4.2.) i) The assets to be immediately downgraded to substandard or other appropriate category of NPAs after restructuring.ii) All other prudential norms as applicable for CDR Accounts would be applicable to these accounts to the extent relevant. iii) Banks to have their own policies regarding operational matters relating to disposal of such applications Advances affected by natural calamities (Para 4.2.3) The Group has excluded from its purview the restructuring of advances in case of natural calamities. The restructuring of advances of the borrowers who suffer from natural calamities will be done as per separate set of guidelines issued by RPCD from time to time. The Group does not propose any change in this regard. 5.4 Disclosures (para 4.3) 5.5 Changes proposed in the prudential norms relating to restructuring of advances ( para 4.1.4 & 4.2.4) The Group has suggested certain changes in the prudential norms applicable to restructured advances, in addition to those effected under CDR Mechanism, which are mostly in the nature of clarifications. These provisions enumerated below may also be applied to advances restructured under CDR mechanism: 5.5.1. Computation of diminution in the fair value of the loan ( para 4.1.4) b) The present value of future interest income based on the actual interest charged as per the restructuring package and of the installments of principal as per the revised repayment schedule (the original (residual) repayment schedule if not changed) For the purpose of calculation of the present value as indicated above, the discount rate used will be the current BPLR as on the date of restructuring plus appropriate term premium and credit risk premium as on that date. ii) In the case of accounts classified as 'Doubtful', total provisions held including the provision in lieu of sacrifice/diminution in the fair value of the loan( but excluding any provisions in the nature of reversal of unrealized income), should not exceed 100% of the book value of the loan. 5.5.2. Provisions against the equity created by conversion of unpaid interest ( para 4.1.4 C) In the case of equity created by conversion of overdue interest, full provision should be held. Any diminution in the value of such equity subsequently should be adjusted against the provision held. The interest income may be finally recognized on cash sale of the instrument, equivalent to the sale proceeds. Any amount realized in excess of original rate of equity may be accounted for as profit on sale of investments. 5.5.3. Reduction in rate of interest consequent upon improvement in the rating of the borrower/ general decline in rate of interest ( para 4.1.4.G) i) Reduction in the rate of interest in the case of first restructuring i) The notional rate for the particular borrower may be determined by adding to existing BPLR the credit risk premium and term premium applicable to the category of the borrower. ii) Any reduction in the rate of interest equal to the difference between the fixed rate of interest being charged and the rate of interest determined as indicated in para (i) above may not be treated as a concession and therefore the account not treated as having been restructured. ii) Reduction in the rate of interest in the case of second restructuring a) Where Interest rate fixed on the restructured loan is linked to BPLR: In case of restructured accounts where interest is linked to BPLR, if the reduction in rate of interest is done only to the extent that the original difference between the spread justified by the rating and the spread actually charged is maintained, it need not be treated as second restructuring. For instance, if the rate justified by the risk rating was BPLR + 5% and the borrower was charged BPLR + 2% after first restructuring, the concession given is 3%. Now suppose the improvement in prospects of the industry to which the unit belongs or in the borrower's financial position results in better credit score for the borrower and the rating improves with the result that the risk premium justified by the rating is reduced to 4%. In that case, the bank may lower the rate to BPLR + 1%, (maintain the level of concession given) and pass on the benefit of improved rating to the borrower. b) Where rate of interest rate on the restructured loan is fixed In cases where rate of interest on restructured accounts is fixed, the benefit of reduction in rate of interest without attracting provisions of second restructuring can be passed on to the borrower by notionally converting the fixed rate being charged as per first restructuring into BPLR + risk premium and applying the framework suggested above. 5.5.4 Asset classification of repeatedly restructured accounts ( para 4.1.4 E) Under CDR mechanism the regulatory concessions in asset classification are not available if the account is restructured for the second or more times. In case a restructured asset, which is a standard asset on restructuring, is subjected to restructuring on a subsequent occasion, it should be classified as sub-standard. If the restructured asset is a sub-standard or a doubtful asset and is subjected to restructuring, on a subsequent occasion its asset classification would be reckoned from the date when it became NPA on the previous occasion. However, such assets restructured for the second or more time may be allowed to be upgraded to standard category after one year from the date of first payment of interest or repayment of principal whichever falls due earlier in terms of the current restructuring package subject to satisfactory performance. These norms may be extended to all other accounts also as they are aimed at preventing the misuse of restructuring to defer the downgrading of accounts. Further, all cases involving reschdulement / rephasement should be treated as second restructuring, if such reschdulement/ rephasement results in reduction in the present value of the loan (principal / interest cash flows), irrespective of whether the terminal date is postponed or not. However, if the modification does not result in reduction in the present value of principal / interest cash flows, it need not be treated as a second restructuring, provided the advance continues to be fully secured. 5.5.5 Impact of changes in non-financial terms of the loan ( para 4.1.4 H) Any changes in the terms of restructuring which do not result in reduction in the present value of the loan (principal plus interest cash flows) or the advance being rendered partially / fully unsecured need not be treated as restructuring. 5.5.6Computation of provision in lieu of sacrifice in element of interest in the case of FITL ( Para 4.1.4 I) 5.5.6.1 FITL created as part of restructuring package 5.5.6.2 FITL created during the implementation of the project i) Provisions against FITLa) If the account is classified as NPA, after restructuring or otherwise, the entire FITL amount should be provided for as hitherto. b) After upgradation of the account, the provisions made against the FITL may be reversed. ii) Provisions against diminution in the fair value of FITL due to reduction in rate of interest a) There may be cases where the account is restructured as a standard asset and rate of interest on FITL is reduced with or without elongation in the repayment schedule. In such cases, the bank would not be holding any provisions against the FITL. Therefore, the diminution in the fair value of FITL (both principal and interest) should be computed as per usual norms and provision for diminution made. b) In cases where the account is classified as NPA after restructuring, no provision is required for any diminution in the fair value of FITL during the period when account continues to be NPA because FITL during this period is otherwise required to be fully provided for. However, after upgradation of such accounts, the full provision will be reversed, and therefore, the diminution in the fair value of FITL (both principal and interest) should be computed as per usual norms and provision for diminution made. iii) Banks should not fund, through FITL or otherwise, the interest charged beyond the original date of completion of project, even if the borrowers capitalize the interest as per usual accounting norms applicable to them. 5.6 Applicability of capital market exposure norms to equity created by conversion of debt (Para 4.1.4 D) Under CDR mechanism equity acquired by way of conversion of debt / overdue interest under the CDR mechanism is allowed to be taken up without seeking prior approval from RBI, even if by such acquisition the prudential capital market exposure limit prescribed by the RBI is breached, subject to reporting such holdings to RBI, Department of Banking Supervision (DBS), every month along with the regular DSB Return on Asset Quality. However, banks will have to comply with the provisions of Section 19(2) of the Banking Regulation Act 1949. Acquisition of non-SLR securities by way of conversion of debt is exempted from the mandatory rating requirement and the prudential limit on investment in unlisted non-SLR securities prescribed by the RBI, subject to periodical reporting to RBI in the aforesaid DSB return. The above exemption should be extended to all non-CDR cases also. 5.7 Changes in the existing SME framework ( Para 4.2.4)The revision to CDR guidelines was effected in November 2005 after issuance of guidelines on SME Debt restructuring. Hence, some of the prudential norms applicable for CDR Mechanism have not been applied to SME debt restructuring. In order to bring about parity in the application of prudential norms, all the norms applicable to CDR Mechanism should be applied to all SME Accounts above Rs. One crore, as is being proposed in respect of all such accounts in other sectors.
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