RBI's loan restructuring scheme has a good chance of success

The RBI's loan restructuring scheme is now on. It is only for corporates. For SMEs, there is a separate scheme that was unveiled in 2019. 

Restructuring will become imperative with the ending of the six month interest moratorium on August 31, 2020. Unfortunately, it is not ended as yet because a petition on chargeability of interest in the moratorium period is pending before the Supreme Court. 

There is an issue of whether interest can be charged at all; there is a further issue of whether interest on interest can be charged, that is, whether the interest during the moratorium period can be capitalised and added to the outstanding loan as on August 31. 

The Supreme Court will hear the matter again on September 28 after  the government submits an affidavit outlining its position on the petition before the SC. A three member committee under former CAG, Rajiv Mehrishi, has been set up to define the government's position.

About the restructuring scheme, there are doubters. Many see the scheme as yet another attempt to kick the can down the road. Precisely because the market is sceptical, the scheme has a better chance of success. Banks will want to keep the proportion of restructured loans down to the minimum if they don't want their valuations driven down. 

Secondly, provision coverage ratios at banks are higher than in the past, so they don't have to worry about recognising bad loans as much as before. 

Thirdly, the RBI and the KV Kamath committee have laid down fairly stringent norms for restructuring. The tenure of a loan can't be extended by more than two years, for instance, and for 26 sectors, thresholds in respect of key financial parameters have to be observed.

So there's reason to believe that this restructuring exercise won't go the way of earlier ones.

The practical problem for banks is how to decide the extent of restructuring given the uncertainties about the growth outlook. I believe it makes sense to wait for a month or two and gauge the strength of the recovery before rushing into restructuring plans (except where default is imminent). They must also put in provisions for an upside to repayments that is linked to cash flows.

A good bit of non-restructured loans will have to be provided for. There will also be slippages in respect of loans that meet the requirement that no default should have occurred more than 30 days prior to March 31, 2020 (which requirement is laid down to ensure that the restructuring covers only covid 19-induced stress). Banks, especially public sector banks, will need capital. Unless adequate capital is forthcoming, the objective in cleaning up bank balance sheets, which is to ensure higher credit flows down the road, will not be met.

More in article in BS, Loan restructuring: this time is different