Meaning of Restructuring of Accounts

Credit account restructuring entails a shift in the account’s structure, with the primary goal of preserving the economic value. Debt restructuring is a mechanism that enables a creditor in financial distress to reduce and renegotiate delinquent debts in order to boost or recover liquidity and rehabilitate so that it can continue to operate.

RBI Guidelines for Restructuring of Advances:

The RBI has detailed guidelines for restructuring advances that apply to industrial units in its master circular on Prudential Norms on Income Recognition, Asset Classification, and Provisioning pertaining to Advances which are both outside and within the Corporate Debt Restructuring mechanism, MSME’s, and all other advances.

  • Both accounts, whether standard, sub-standard or doubtful  may be restructured by banks, but not with retrospective effect.
  • Restructuring of accounts is not possible unless the unit’s financial viability is defined, which is determined by certain viability benchmarks such as Return on Capital Employed, Debt Service Coverage Ratio, Internal Rate of Return, Cost of Funds, and the amount of provision needed in favour of the decrease in fair value of the restructured advance.
  • Any restructuring that is carried out without considering the borrower’s cash flows and evaluating the feasibility of the projects or activities funded by the banks would be viewed as an effort to evergreen a bad credit facility.
  • Accounts with fraud, malfeasance, or wilful default are also ineligible for restructuring.

Major Restructuring Tenets

The Reserve Bank of India (RBI) has outlined several restructuring principles.:

  •  Except in exceptional circumstances, all bank debts should be completely covered by tangible assets (primary + collateral):
    • MSME borrowers with a balance of up to Rs 25 lacs in arrears and
    • Infrastructure projects, as long as the project’s cash flows are sufficient to repay the loan and the funding bank has a clear and legitimate first claim on the cash flows.
  • In the case of infrastructure operations, the unit should be viable in 8 years, and in the case of other units, it should be 5 years.
  • In the case of infrastructure, the repayment period should not exceed 15 years, and in the case of other advances, it should not exceed 10 years.
  • The promoter’s contribution or additional fund injection should be at least 20% of the bank’s sacrifice, i.e. a reduction in the fair value of the advance or 2% of the restructured debt, whichever is greater.

What Happens When Accounts are Restructured

Standard assets will be reclassified as sub-standard assets, substandard and doubtful assets will be reclassified as doubtful assets, respectively. These can only be upgraded if the principal and interest on all of the account’s facilities are repaid according to the terms of the restructuring plan within the time span stated.

The fair value of the advance will be reduced if the interest rate is reduced or the principal balance is rescheduled as part of the restructuring. The bank will suffer an economic loss as a result of the decrease in valuation, which will have an effect on the bank’s market value of equity. As a result, banks must calculate the decrease in the fair value of the advance and make allowances for it by debiting the Profit & Loss Account.

Impact of Restructuring of Advances on Banking industry

All of the above system looks good for the banking industry, as if everything would be clear and overboard. Banks and creditors have resorted to restructuring in the last few years that was completely out of proportion. There may be a variety of explanations for this.

The Reserve Bank of India had offered an asset classification opportunity until March 31, 2015, in exchange for a fast implementation of the restructuring package (except for a few sectors such as consumer & personal loans, Capital market exposures and Commercial real estate exposure).

It means that, under current RBI guidelines, a regular account is degraded to the substandard category upon restructuring, and an existing NPA is degraded one notch further; however, as an opportunity for swift implementation, these guidelines were not applicable until March 31, 2015. As a result, starting April 1, 2015, this special opportunity will no longer be valid.

Banks took advantage of this opportunity in order to avoid overburdening their balance sheets with non-performing assets, and borrowers took advantage of the banks’ vulnerability. Healthy units portrayed themselves as poor, allowing them to usurp concessions from banks, while sick but unviable units were able to snare additional funds from their lenders. The banks, at the end, are at losses. Good money has gone to deserving people or has been squandered on poor money.

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