July 2021

Financial Institutions: Post SC’s Loan Moratorium Judgement

The resilience of Indian financial institutions including banks and NBFCs has been tested hurling many, if not all, on the edge. With no end in sight to the COVID-19 pandemic, the Supreme Court pronounced its judgment in the loan moratorium case holding every borrower, irrespective of the outstanding loan, as eligible for the compound interest waiver for the March-April period.

Previously, the Reserve Bank of India (RBI) had permitted deferred repayment to help borrowers sail through the adverse impact of the COVID-19 pandemic that left masses unemployed in great numbers. In that vein, the government had agreed to bear the burden of compound interest waiver for retail and small business loans up to ₹2 crores and as a result, waived interest payment during the moratorium period starting from March until August.

Simply put, a variety of loan borrowers including but not limited to, MSME and retail loans shall be exempt from payment of the compound interest or the interest-on-interest that banks were accruing over the six months of the moratorium, which was a heated matter of contest at the time of announcement of the moratorium.

Additionally, under this scheme, borrowers that had continued repaying their loans as per schedule shall also benefit from it. For such borrowers, it shall be assumed that they had availed of the moratorium and the compound interest that would have accrued will be adjusted against their outstanding loans.

While this move was jubilantly welcomed by the borrower community, the Indian Banks’ Association (IBA) scurried to the government seeking reimbursement of the compound interest that has to be returned to borrowers the absence of which would severely dent the profitability and sustainability of banks and non-banking institutions.

The probable downside to bearing the burden resulting from the waiver of compound interest would be that financial institutions may start passing down the financial impact to the depositors thereby going against the waiver scheme in letter and spirit.

Interestingly, banking and non-banking financial companies are yet to receive their share of reimbursements in the first round of waivers. This first round of waivers has been anticipated to cost the government approximately Rs. 6,500 crores, however, the data on the quantum of reimbursement requests received remains unknown as of date.

The recent pronouncement, though similar to the last round of waivers announced in October, requires additional relief of around Rs. 7,000 – 7,500 crores to be provided to borrowers estimating the overall hit to the financial sector for the waiver at around Rs. 14,500 crores. Invariably, an extension of the waiver scheme with higher financial limits to over 27 COVID-19 impacted sectors including restaurant and hotel sectors is a stride taken in the right direction.

In addition to this, this order throws light on the asset classification issue for lenders as the Supreme court ruled out any further moratorium. Even if there was a stay on asset classification, banking institutions are preparing themselves for the impending risks by classifying borrowers’ profiles based on their repayment behavior and have identified loans that would have slipped to non-performing if not for the SC September order.

In view of the above, it is clear that if the government refunds monies to the banks, there would be no impact on the banks but affected borrowers would receive significant relief. It goes without saying that a total waiver of interest during the moratorium period would have a far-reaching economic consequence on the Indian economy.

Such a payback of interest to depositors constitutes one of the most essential banking activities and is also a huge responsibility owed by the financial institutions to the Indian masses who survive on the interest from their deposits. 

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MSME Sector – The Pre-Pack Paradigm and Saving Grace

The GST regime led to some initial teething troubles and subsequently things were settling down for the Micro, Small and Medium Enterprises (MSMEs). But the country-wide lockdown has again left the MSME sector scrambling for finances to stay afloat.

To battle, the economic depression, the Reserve Bank of India (RBI) injected liquidity and extended credit lines by way of a special relief package, including a moratorium on loans with a view to protecting businesses from drowning in a quagmire of unquantifiable uncertainty, debt, and litigation.

However, several banks and NBFCs went against the spirit of RBI’s relief by not passing on the loan moratorium benefit to borrowers, thereby causing tremendous economic stress. With the moratorium clearly being a half-baked solution, additional measures were required to help distressed MSMEs – that employ a sizeable population and contribute over 30% to India’s GDP.

In view of the existing recovery gap, the government promulgated an ordinance allowing the use of pre-packs as an insolvency resolution mechanism for MSMEs with defaults up to Rs 1 crore, under the Insolvency and Bankruptcy Code, 2016 (IB Code).

This move comes soon after the end of a one-year suspension of insolvency initiation imposed by the government on the pretext of the Covid-19 pandemic, wherein the minimum default threshold for insolvency proceedings was increased from Rs 1 lakh to Rs 1 crore.

With the increase in threshold to 1 crore, numerous operational creditors especially MSMEs were deprived of remedies under the Code during the last year. Therefore, it appears that the Ordinance has been meticulously formulated to soothe distressed MSMEs while placing the pause button on frivolous litigation emanating from losses that occurred during the pandemic. 

The pre-packaged insolvency framework across jurisdictions is known to plug this wide recovery gap. In fact, pre-pack resolution plans are likely to facilitate adherence to the timelines prescribed under the IB Code. MSMEs have suffered the most during the pandemic and placing a strict timeline of 120 days by virtue of the pre-pack model is likely to support ailing MSMEs.

As a result, the Ordinance is likely to provide a cost-effective and faster resolution process for MSMEs under the debtor in possession model, unlike the normal CIRP where it is the Resolution Professional (RP) in possession. 

Simply put, under the pre-pack insolvency framework for MSMEs, the debtor shall continue to control and run the company till resolution takes place, whereas, in the normal CIRP, the RP waltz’s in and takes over the debtor company on the day of admission itself.

This model shall provide tremendous flexibility and a free hand to existing promoters of MSMEs as well. Further, the pre-pack model will help distressed companies-Corporate Debtors to enter into consensual restructuring with lenders and address the liabilities of the Company.

In addition to this, several procedural requirements on issues, such as claims of creditors may be simplified to make the entire process less rigorous under the MSME framework.

With the ever-evolving nature of the IB Code and insolvency professionals still adapting to the varying levels of power entrusted in them, it will be interesting to see how the debtor companies shall manage to address their liabilities in consonance with this Ordinance.

Under the debtor-in-possession model, there lies the further scope for strengthening both the financial and operational position of MSMEs, importantly under prevailing Covid crises. Therefore, in view of the changing dynamics, it is pertinent for debtor companies to have to be aware of their own self-worth before undergoing the pre-pack insolvency route to truly salvage the status of such debtor company and revive the business again without resorting to desperate acts of litigation. 

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