BackDebt resolution framework: A balance of relief and rigour
RBI’s prescriptions based on the Kamath Committee report could aid a revival of viable businesses while also engendering better credit discipline
PremiumThe Reserve Bank of India (RBI) struck a balance between relief and rigour in its resolution framework for covid-related stress issued on 6 August 2020, giving businesses affected by the exogenous shock of covid a necessary reprieve by permitting restructuring without requiring change of control, while also creating strict boundary conditions for such restructuring. These principles have been carried forward in a circular issued on 7 September 2020 setting out the financial parameters for restructuring under the framework on the basis of recommendations made by an expert committee under the leadership of industry veteran K.V. Kamath. The central bank and the panel deserve praise for releasing this within a tight deadline. The provisions of the circular are simple. With five cogent parameters, it permits the requisite flexibility needed for such an exercise within baseline prescriptions, and is therefore capable of timely implementation, which is critical given the severity of stress.
In its circular on financial parameters, RBI has prescribed sector-specific thresholds for 26 key sectors. This is expected to bring in the required level of uniformity (and where relevant, also sector-specific calibration) and rigour in assessing the impact of covid on companies and preparing resolution plans. The central bank has prescribed five parameters that act as ceilings and floors, as the case may be, for lending institutions whilst preparing resolution plans. Such parameters will provide flexibility to borrowers as well as address the need for business sustainability in the near future, with lenders also free to stipulate other parameters in addition to the mandatory ones. The circular specifically recognizes the varying impact of the pandemic on different sectors and businesses, and lets lenders, at their discretion, adopt a graded approach—this could include classification of the impact on borrowers into mild, moderate and severe, as recommended by the Kamath Committee—based on the severity of the impact on borrowers, while preparing or implementing resolution plans. By way of example, the circular accords some leniency in the financial ratios to be prescribed for the aviation and tourism sectors in recognition of the deeper and perhaps longer term impact of the pandemic on these sectors on account of customer behaviour.
The need to project future cash flows and meet thresholds on key parameters will also give bank managements some flexibility in dealing with individual accounts, but appropriate boundary exists in the form of the mandatory minimum. This approach therefore balances the commercial judgement of lenders with the need for some uniformity across sectors.
Further, the parameters are baseline ceilings or floors, and these ratios can also be strengthened based on cash flow projections, striking an equilibrium between prescriptive parameters and proportional flexibility. The focus on cash flow projections, in particular, marks a shift in favour of lending and restructuring to be based on the strength of the borrower’s business model and the revenues it generates, rather than asset-based financing alone and a dependence on the borrower’s ownership, although deleveraging concerns do continue to be prioritized (promoters could be asked to infuse equity). In all, this will place in focus appraisals of business by lenders and assuage any concerns of debt recasts being open-ended.
The central bank has reinforced the criticality of all lenders acting together, and has sought to strengthen the inter-creditor agreement (ICA) mechanism by clarifying that it is mandatory and compliance shall be assessed as part of its supervisory review. RBI’s covid resolution framework has prescribed additional provisioning by banks on account of failure to sign an ICA within 30 days of a debt recast invocation, while the circular on financial parameters refers to the mandatory nature of signing ICAs too. This should encourage the signing of ICAs by all stakeholders while preparing resolution plans, and encourage collective action by lenders, rather than individual enforcement—all of which would help engender better credit discipline.
Finally, monitoring has been stipulated for these parameters on an ongoing basis, as also outer limits for compliance. The circular on financial parameters has asked for key ratios to be maintained as per resolution plans by 31 March 2022 and on an ongoing basis thereafter, and these are to be monitored as financial covenants and during subsequent credit reviews. The requirement for maintenance of escrow accounts will also aid monitoring and control.
We now have a framework for debt resolution that was acutely needed, given the stress across the economy. This will foster the revival of viable businesses, giving them a fresh lease of life and a sustainable path to recovery.
L. Viswanathan and Richa Roy are partners at Cyril Amarchand Mangaldas
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