The virus-induced lockdown has raised “Liquidity” and Non-Performing Assets (“NPA”) issues popularizing the buzzwords in financial circles and beyond. Anticipating a domino effect on loan defaults amongst small to medium-sized businesses, the Finance Ministry in conjoined efforts with Regulators and the Reserve Bank of India (RBI), introduced numerous measures for the maintenance of equilibrium between the market forces of demand and supply during the pandemic.
One of the preliminary measures taken by the Ministry was the suspension of Sections 7 and 9 of the IBC, followed by a moratorium on loan payments until August 31. While this move was appreciated by Corporate Borrowers at the outset, a closer look at the policies revealed deep financial woes in the long-run. Consequently, the embargo may pause the economic ripple effect on businesses for some time, but does not discount or waive off payment liabilities due to losses that occurred on the pretext of COVID-19; however the increase in threshold value to Rs. 1 crore for initiation of insolvency leaves out a massive chunk of small to medium businesses having debts lesser than 1 crore leaving them limited options of traditional litigation, which are time-consuming and expensive.
Further, relaxations in compliance requirements, an extension of the ITR filing deadline to November 30th along with deferred interest payments in relation to loan moratorium are myopic and are likely to create issues in the long-term for all stakeholders. These measures are collectively aimed at keeping businesses afloat while testing the resilience of financial institutions offering relaxations – a necessary cushion. Loan-loss provisioning for NPAs as mandated by the newly-introduced amendments has seriously eroded the capital base of several banks, limiting their ability to make further loans. There is general consensus that the state of Indian banking is among the biggest challenges facing the country in accelerating investments, growth, and sustainability.
A cherry on the cake for defaulting Corporate Borrowers was last week’s Supreme Court’s ruling which stated that Default will not result in NPA until further orders. In view of this, the accounts which were not declared NPA till August 31 shall not be declared NPA till further orders. RBI’s circular dated 27th March 2020 was considered to be ultra vires to the extent that it was charging interest on the loan amount and also charging interest on interest (compound interest) on the deferred loans during the moratorium period.
In light of this, all pertinent decisions cannot be left to individual banks and the Supreme Court stated that clarification on interest upon interest will have to be obtained. The main purpose of the moratorium was to provide a sigh of relief to those in distresses and not as a weapon or an opportunity for those already defaulting on payment of their loan amounts. This pandemic created hardships to the borrower’s especially individual borrowers and also obstruction in the “right to life” as guaranteed by Article 21 of the Constitution of India. Also charging compounding interest during the moratorium period in the wake of the COVID-19 pandemic had no merit as such as held by the apex court.
Non-recognition of NPAs until the end of this year will certainly distort the harsh reality of mounting NPAs in the country and the increasing burden on financial institutions. With the shadow financing industry already struggling with funds in light of recent crises such as the IL&FS fiasco, COVID-19 has further jeopardized the survival of the sector at large. At this juncture, it is necessary to implement an all-encompassing framework supporting the demand and supply side of the economy so as to avoid any potential systemic risks to the financial sector and accordingly take corrective steps.
As the nation awaits orders from the apex court, there is a dire need for the RBI to develop better mechanisms for monitoring macro-prudential indicators, especially to watch out for credit bubbles. Over the medium term, a simple indicator would be a rate of credit growth that is way out of line with the trend rate of growth of credit or with the broad growth rate of the economy. This way, the economic ripple effects throughout the country can be traced and mitigated at the source to avoid further damage.
The pandemic has drastically reduced the Indian GDP by 23 percent ruling out a waiver of interest on bank loans during the moratorium period for all borrowers providing a suggestion of long-term rescheduling. Any “ex post facto” change in terms and conditions of the moratorium favoring those who availed of it over those who made the extra effort of repaying would be grossly inequitable and patently unfair for those who did not avail of the benefits of moratorium initially or gave it up subsequently.
With the scales of economic relief mostly tipped in favor of small-scale borrowers, it further paves way for banks to restructure loans. In fact, NBFCs have requested RBI to allow them a one-time restructuring of all loans till March 2021, as their borrowers are facing funding issues amid the pandemic. This is a preferred move for financial institutions as there won’t be any buyers in a cash-strapped economy, even if impacted companies are taken to bankruptcy courts.
So it is wise of financial institutions to work out a restructuring package without calling for a change in ownership while allowing the loans to remain ‘standard’. However, misuse of previous restructuring frameworks by promoters has made the RBI wary of approving any such rejig with existing promoters at the helm. Bankers are mindful that any proposal has to have strong checks and balances to ensure it is not misused.
Despite these measures, a formidable overhand of NPAs may linger long after the COVID-19 pandemic dust is settled. Restructuring of loans is a static relief formula and may derail the debt rehabilitation process. Subsequently, this shall defer NPA recognition, as it did a few years ago, however restructuring may rose tint balance sheets for a few months but the risk of an impending credit bubble burst is a high possibility if a custom policy to sustain the economy is not implemented in a timely manner.