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On Tuesday RBI had done the first tranche of OMO following the tightness in the commercial paper market. (Mint )
On Tuesday RBI had done the first tranche of OMO following the tightness in the commercial paper market. (Mint )

Loan restructuring to hit credit score, eligibility

The Reserve Bank of India allowed a one-time restructuring of loans after the six months’ moratorium facility got over in August

The Reserve Bank of India’s (RBI) move to allow lenders to restructure loans of borrowers who are facing financial difficulties may ease you up but be ready to deal with lower credit scores and loan eligibility.

RBI allowed a one-time restructuring of loans after the six months’ moratorium facility got over in August. The regulator has allowed lenders to retain these loans as “standard" on their books, which will help lower their non-performing assets (NPAs), but report them as “restructured" to the credit bureaus. Loans reported as restructured have a negative impact on the credit scores of borrowers.

“Credit scoring algorithms are statistical regression models that consider this variable (restructuring) while calculating the overall score along with other factors," said Manu Sehgal, business development leader, India, Middle East and Africa, at Equifax.

This will affect your loan eligibility as well. So before you approach your financial institution to restructure your loan, understand how it will impact your credit score and related lending criteria.

The impact

According to the frequently asked questions (FAQs) on HDFC Bank’s website on loan restructuring, the lender will report all the loans that a borrower has as restructured even if the facility has been opted for only one. In other words, if you have an outstanding credit card amount, a personal loan and a car loan with the bank, and you ask it to recast any one of the three, all of them will be reported as restructured to credit bureaus.

“Banks generally report restructured loans under the ‘written off’ or ‘settled’ section," said Sehgal. Lenders, typically, look at loans that are "written off" or “settled" as a wilful default, according to banking experts.

Most banking industry officials who spoke to Mint could not clarify how severely loan restructuring could affect credit scores of borrowers. “It is still not clear. It is a unique situation. As far as we know, the algorithms haven’t changed," said Navaneetha Krishnan, head, credit policy and process transformation, BankBazaar, an online marketplace for financial products.

Krishnan said banks have no choice but to follow RBI’s regulations. “But not many lenders are in favour of downgrading credit score as reportedly mentioned by a State Bank of India (SBI) official during a recent press conference," he said.

Reporting loans as restructured can also impact a borrower’s ability to avail a loan or credit in the future. “How much impact restructured loans would have on an individual’s credit score is not yet clear. However, there would be an adverse effect on the eligibility of these borrowers for availing of any kind of lending product in the future," said Radhika Binani, chief product officer, Paisabazaar.com, an online marketplace for financial products.

In the past, banks would restructure loans given to retail borrowers only after they turned into NPAs. Lenders did it only after they were convinced that the borrower intends to repay but needs some time and concession.

This time it’s different. “RBI has allowed lenders to implement a resolution for eligible loans without downgrading the asset classification, which stays standard," said Ashish Singhal, managing director, Experian Credit Information Company of India, a credit bureau. It’s an important change in RBI’s resolution framework for covid-19-related stress, he added.

What you can do

If you opt for restructuring of a loan, there is little that you can do about your credit score, as of now. However, you can work towards improving it.

When calculating a credit score, bureaus assign more weight to recent financial history—one to three years. So ensure that you repay your EMIs on time after the recast. Avoid taking any fresh loans, if possible, and gradually bring down credit utilization to 30-40%. Credit utilisation shows the percentage of credit the borrower has availed of the total credit facility available. Remember that credit scores improve only over time.

The road ahead

The current arrangement appears lopsided in favour of lenders as they don’t need to declare restructured loans as delinquent, lowering NPAs on their books, but the burden on already-stressed borrowers will only increase with a lower credit score.

Borrowers will be paying extra in any case. First, they will need to pay a fee. SBI, for example, is bumping up the interest rate on home loans by 0.35% for restructuring them.

Second, the amount of interest a lender loses during the restructuring period will be added to the principal amount. Suppose your loan has been recast for two years, and you are now supposed to pay Rs3 lakh instead of the Rs5 lakh, according to the original schedule. The remaining Rs2 lakh will get added to your principal, increasing your overall interest outgo.

Repayments usually get affected during natural calamities. According to Parijat Garg, former senior vice-president with a credit bureau, the regulator should come up with a new classification for borrowers who get impacted by natural calamities. “RBI can ask lenders to flag such borrowers while reporting their data, so that credit bureaus can omit the flagged data while calculating the credit scores. This way, credit scores of those affected by natural disasters or a pandemic won’t get affected," said Garg.

RBI could have issued guidance to lenders and credit bureaus that restructured loans should not impact credit scores, in the current circumstances, he added.

Until the regulator takes a call on it, borrowers will get the short end of the stick. They will pay extra for loan restructuring, bear the financial burden that comes along with it and also see their credit scores going down.

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