Restructuring of loans is always a debatable issue as it runs the risk of adverse selection. In this game, both the bank and the borrower are comfortable with the concept. The borrower gets extensions in various forms while the banker can defer recognition of the non-performing asset, save on provisioning and, hence, capital. The government too is happy with this solution as the NPA levels are lower and India Inc is not complaining. It is a pareto-optimal situation. But, the critic’s view is that such actions only kick the can down the road, as restructuring allows us to run away from the obvious. It is just deferring the problem as money not paid is default, whichever way one looks at it.
There is evidently a perverse incentive to go for such restructuring, so there is a need for objectivity in selection. Normally, such decisions are taken by the lenders, and the majority-rule among them becomes the overriding factor. In the present situation of several companies and industries being affected by the shutdown, objectivity should be used to select the candidates. While the current crisis calls for universal restructuring, it should be consciously done, by separating the companies which have been hit by the pandemic and its fallout from those which were not doing well, yet require assistance as they have been pushed further back. The ones which were non-performing prior to the lockdown also require legitimate support as they can turn the corner if restructuring is done judiciously.
Some of the following parameters can be used for separating this chaff. First, a cut-off date for companies which were standard assets on the books of banks that turned negative due to the lockdown can be decided. This is something already included in the RBI policies, where March 1 can be used as the threshold. If companies were not performing at this point, they would go into category B, which can then have differential solutions.
Second, companies which have taken the moratorium in March should get precedence as these assets were recognised as being under pressure right from the beginning. Hence, in terms of hierarchy, additional weight can be given here.
Third, the financial performance in Q1 of the present year must be evaluated in terms of sales and expenditure growth besides interest cover ratio and profitability. This will reflect how much the company has been impacted in this quarter over the last five quarters. Comparisons with the Q1 and Q4 quarters of FY20 would be important. Here, most companies will qualify as the results have been dismal for most sectors.
Fourth, industries need to be segregated based on different operational levels as of a cut-off date, which can be either June or September. Some like pharma, FMCG and IT were working even during April, albeit to a limited extent, and those like hospitality, tourism, entertainment are virtual non-starters even today. By such categorisation into industries that have been ‘most’,’ moderately’ and ‘less’ affected by the shutdown, a stepdown view becomes possible.
Fifth, the prospects of the industries need to be independently worked out, probably by credit-rating agencies as their view is unbiased. This will help to put companies in various buckets of time taken to reach normalcy. The advantage here is that the tenure for restructuring can be ascertained. For example, if independent research shows that real estate will revive in March 2021, while entertainment only in October 2021, the loan restructuring can be differentiated. The time would not be uniform for all industries as is being done for SMEs. Having a uniform time for this exercise could give benefits for extended periods.
Sixth, loans that must be restructured can be bracketed into categories based on the interest cover ratio across different size groups of credit. The restructuring exercise would involve changing the tenure for repayment as well as changes in the interest rate. The banks must be involved as this affects their commercial profitability. The tenure and interest rate can be linked to the size of the loan. A different norm can be set for smaller size loans.
Seventh, the restructuring package would have to be made conditional. These would have to be in terms of curbs on dividend payment, pay packages of the management, operational expenses like travel, etc. Also, commitments to trade creditors would have to be adhered to. This is essential as all companies would like to go in for such an exercise, especially if the tenure is extended and interest is lowered. The conditions would restrict the free-riders.
Eight, any restructuring of loans of a company would also entail sanctioning of fresh loans as the former only repackages the loans which help companies survive. But, for growth, fresh loans will have to be advanced to ensure that the company is back on the growth path. The extent to which fresh loans can be given can be linked with the fourth factor.
Nine, to make the new credit feasible for banks and viable for the borrowers, the government must provide a credit guarantee in an analogous manner, as has been done for the SMEs. This can again be sector-specific for well-defined time periods. This will protect banks in the future and can be done selectively.
Last, the restructuring of loans will evidently mean a loss for banks as any loan that is not serviced on time involves a cost. It is a zero-sum game. The government would have to contribute, with interest subvention targeted at sectors where the exercise involves lowering of interest rates by more than 200 bps. This cost should be shared between the two.
Having an objective approach, which is driven by formula rather than subjective judgments of the lenders would make the exercise more transparent. The first five parameters mentioned could be used to derive the formula, while others would form the structure of such deals. A system which allows for subjective judgments carries with it the disadvantages that go with ‘groupthink’, where all merely agree because others do. The principled approach will be more targeted, as the more vulnerable sectors could get more liberal terms. Also, as stated earlier, restructuring on the grounds of Covid-impact holds for both the standard and impaired assets at the cut-off point. Both require attention. The formula-driven process will clearly define the perimeter of allowances to be made.
Hence, based on the ten parameters stated here, a weighted score can be assigned by running an algorithm to find out which companies qualify for the restructuring plan and the terms therein. There would be less room for subjective judgments here as the terms of engagement are pre-decided. The government also would have an important role to play here by both providing a guarantee selectively as well as providing for an interest subvention so that banks do not have to bear the entire cost.
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