Due to the sudden outbreak and spread of coronavirus (COVID-19) across the globe, the financial services sector has been severely hit. In this regard, the Reserve Bank of India (RBI) has issued several guidelines and advisories and put in place regulatory polices to give a benefit to the borrowers to ease the financial crisis. On 27 March 2020, RBI in its statement of development and regulatory policies
has permitted banks and non-banking financial companies (NBFCs) to provide a moratorium to borrowers for a period of three months. Thereafter, the RBI came up with a notification titled COVID-19 Regulatory Package
providing a brief guideline about the relaxation. This was followed by a set of frequently asked questions (FAQs) on RBI’s scheme for a three-month moratorium on loan repayment (https://pib.gov.in/PressReleseDetail.aspx?PRID=1609820
) issued by the ministry of finance.
However, there are still certain issues that are not clear and, due to the ambiguity around such issues, banks and NBFCs have been coming up with their own interpretation. One such major issue was with respect to the grant of moratorium to loan accounts having overdues as on 1 March 2020.
The RBI has permitted banks and NBFCs to provide a moratorium to borrowers for a period of three months. However, there is still confusion among the lending institutions regarding the asset classification of loan accounts. The recent judgement of the Delhi High Court in the case of Anant Raj Ltd Vs Yes Bank Ltd dated 6 April 2020, seeks to provide some clarity on the issue.
Regulatory Package by RBI
Before examining the issue let us understand that the underlying objective of RBI’s guidelines was to inter-alia ease the financial stress caused by COVID-19 disruptions by relaxing repayment pressures and improving access to working capital. The COVID -19 regulatory package provides for the rescheduling of payments pertaining to term loans and working capital facilities.
Several contentions have been raised to say that the moratorium is not applicable to the borrowers who are already in default as on 1 March 2020.
The argument to support this contention is that the language of the regulatory package clearly states that the three-month moratorium is applicable only to those instalments which fall due between 1 March 2020 and 31 May 2020.
Accordingly, only those borrowers would be covered whose loan account is outstanding as on 1 March 2020 and who were properly servicing their account till that date and were not in default.
This was further supported by a clarification issued through a letter dated 31 March 2020 by the chief general manager-in-charge, department of regulations of the RBI to the chairman, Indian Banks Association, wherein it stated that if a borrower has been in default even before 1 March 2020, then such default cannot be said to be a result of the economic fallout due to the pandemic and the benefit of the moratorium can be extended to such borrowers in respect of payment falling due during the period 1 March 2020 to 31 May 2020. However, payments overdue on or before 29 February 2020 will attract the current income recognition and asset classification guidelines (IRAC Guidelines).
Such an approach will cause all past due accounts to become NPAs during the disruption period and, therefore, the regulatory recognition of the disruption period as not a case of contractual failure but a case of systemic failure, gets defeated. The relaxation or grant of moratorium presumes that during the period 31 March 2020 to 31 May 2020, the borrower has not paid due to a systemic disruption. If the logic of disruption applies to the current dues during the moratorium period, the same logic cannot be inapplicable for the past dues.
For example, a borrower had payments due on 29 February 2020 which was 30 days past due (DPD). In case he cleared all his dues, say on the 31st March, his account, which was, say, 60 DPD on the 29th March, would have been a regular standard account. But the borrower was precluded from paying anything during the disruption period. Thus, the opportunity of clearing any past due payment is not available to the borrower during the period of disruption.
What is a 'default' on the 1st March continues to be a default, but the ageing of the default cannot increase during the disrupted period. The disruption is not a credit event, perhaps, it is an externality, and admittedly a force majeure. Therefore, the disruption causes a standstill on the obligations of the borrower.
The period of disruption is a period during which the clock of the payments in the system stops. If the ageing of past receivables changes, then the disruption will cause all regular accounts to become irregular. In such a case even a 10 DPD on 29th February will become an NPA 19th May. Such an approach will cause all past due accounts to become NPAs during the disruption period, and therefore, the regulatory recognition of the disruption period as not a case of contractual failure but a case of systemic failure, gets defeated.
Delhi High Court Ruling
The recent judgement of the Delhi High Court in the case of Anant Raj Limited Vs. Yes Bank Limited (W.P.(C) URGENT 5/2020), dated 6 April 2020 has given a different perspective to the entire situation.
The matter of dispute was the asset classification of the petitioner. The petitioner’s instalment that was due on 1 January 2020 was not paid within 30 days, due to which the account was classified as SMA-1 and thereafter, since it was not paid within 60 days, the account was classified as SMA-2. Further, it was contended that since the instalment was not paid till 31 March 2020, the account of the petitioner was liable to be classified as NPA.
The court considered the fact that in view of the pandemic COVID-19, RBI has issued several guidelines and advisories and to put in place regulatory polices to give a benefit to the borrowers to ease the financial crisis. The intention of the RBI is to maintain status quo as on 1 March 2020 with regard to all the instalments payment which had to be made after 1 March 2020 till 31 May 2020. Further, the relevant provision of the regulatory package with respect to classification of accounts also indicates that the intention of RBI is to maintain status quo with regard to the classification of accounts of the borrowers as they existed as on1 March 2020. The relevant extract of the judgement is as follows:
27. The restriction on change in classification as mentioned in the regulatory package shows that RBI has stipulated that the account which has been classified as SMA-2 cannot further be classified as a non-performing asset in case the instalment is not paid during the moratorium period i.e. between 01.03.2020 and 31.05.2020 and status quo qua the classification as SMA-2 shall have to be maintained.
This implies that, for a period of three months, there will be a moratorium from payment of the instalment. However, interest shall continue to accrue on the outstanding payment even during the moratorium period. Further, in case the borrower fails to pay the said instalment after the expiry of the moratorium, the asset classification would change as per the IRAC Guidelines.
Deterioration to non-performing asset (NPA) status has manifold consequences, including provisioning requirement that have an impact on the profit and loss (P&L) accounts. For NBFCs, their drawing power from banks comes down as NBFCs are not allowed to borrow against past due receivables. This will exacerbate the liquidity issue with NBFCs. Further, under the ECL provisions under Ind-AS 109, the continuation of default will cause the bucket of the receivables to move from Bucket 1 to Bucket 2, thereby requiring computation of lifetime expected losses. This may mean a huge impact on long-term receivables, as those in case of housing or project loans.
After the high court judgement, two things have been clarified:
1. An account already classified as NPA as on 29th February remains an NPA.
2. If an account that is not an NPA on 29th Feb and is just classified as an SMA, then the ageing of the receivable shall not change during the moratorium and any further asset degradation shall not happen.
Accordingly, the possible scenarios can be summarised as follows:
As per the practice adopted by banks and NBFCs, including the housing finance companies (HFCs), it seems that most of them have extended the moratorium on all standard loans, irrespective of whether they were overdue as on 1st March. Further, after the HC ruling, the asset classification of an account which has been classified as SMA cannot further be classified as a non-performing asset in case the instalment is not paid during the moratorium period and status quo qua the classification as SMA shall have to be maintained. However, there is a possibility that the ruling may be challenged in a higher court and the outcome of that ruling could be completely different. Therefore, until this ruling is challenged further or any clarification contrary to this is issued by RBI or any other authority, financial institutions may consider this ruling to frame their policies for account classification.
(Anita Baid is senior manager at Vinod Kothari Consultants Pvt Ltd)