rbi-selects-5-financial-ratios-26-sectors-for-loan-restructuring

 

After reading this article, answer the following question for Mains answer writing practice. Also you can get your answer checked free of cost by clicking on the following link.

For Mains:https://www.jatinverma.org/home/typepost/dailymainsanswerwriting

Context: The Reserve Bank on specified five financial ratios and sector-specific thresholds for resolution of COVID-19 related stressed assets in 26 sectors, including auto components, aviation, and tourism.

Background:

  • In order to ease the financial stress of cash-strapped businesses and individuals during the lockdown period, the Reserve Bank of India had provided a three-month moratorium for instalments of all term loans. 
  • But with continuing economic stress especially of firms in the high-contact services sectors like aviation and hotel industry, the RBI has now allowed banks the option of restructuring loans of financially stressed firms. 
  • The Reserve Bank of India (RBI) had set up an expert committee under K.V. Kamath to suggest financial parameters for resolution of coronavirus-related stressed assets. The RBI has accepted Kamath panel’s recommendations.

Covid-19 impact on banking sector

  • According to the Kamath committee report, 72 per cent of banking sector debt to industry has been impacted by COVID-19. 
  • Of this, loans worth Rs 22.2 lakh crore (or 42.1 per cent of the debt) were under stress even before the pandemic, while another Rs 15.5 trillion (30 per cent) of loans have been impacted by the pandemic.

Recommendations of Kamath Panel:

  • The panel recommended the sector-specific benchmark ranges for each resolution plan for borrowers with an aggregate exposure of Rs 1,500 crore or above at the time of invocation.
    • Specified sectors for loan resolution: The 26 sectors specified by the RBI include automobiles, power, tourism, cement, chemicals, gems and jewellery, logistics, mining, manufacturing, real estate, and shipping among others.
  • The key financial ratios suggested by the committee are 
    • total outside liabilities/ adjusted tangible networth; 
    • total debt/EBITDA; 
    • current ratio, which is current assets divided by current liabilities; debt service coverage ratio; and average debt service coverage ratio.
  • In case of those sectors where the sector-specific thresholds have not been specified, lending institutions should make their own internal assessments regarding total outside liabilities to adjusted tangible net worth and total debt to EBITDA ratios. 
    • However, the current ratio and debt service coverage ratio in all cases should be 1.0 and above and average debt service coverage ratio should be 1.2 and above.
  • Forensic audit may be required if the account happens to slip beyond the implementation period of 180 days to establish whether there was diversion of funds and identify malfeasance.
  • Signing of Inter Creditor Agreement is a mandatory requirement for all lending institutions in all cases involving multiple lending institutions, where the resolution process is invoked. 
  • Graded approach: Seeing the differential impact of the pandemic on various sectors, the lending institutions may, at their discretion, adopt a graded approach depending on the severity of the impact on the borrowers.

Benefits:

  • Flexible approach in loan restructuring: It differentiated between the financial matrix across various sectors, and gave banks the freedom to choose which accounts to restructure. 
  • Laying down clear entry timelines on which loan accounts are eligible for this scheme can help limit restructuring to those firms whose financial position has been affected by the pandemic. 
  • Ensuring high provisioning norms, as well as offering the option of reversing the provisions, provided the borrower has repaid a significant part of the loan, could disincentivise banks from misusing the restructuring scheme to keep their balance sheets clean. 

Concerns: The Indian experience with restructuring schemes post the global financial crisis of 2008 has not been good. 

  • Stringent conditions: Some of the thresholds are too high for companies in particularly stressed sectors such as aviation to meet. 
    • Adopting indicators like Debt/EBITDA in the framework, implies that highly leveraged companies (having more debt than equity) are unlikely to take advantage of this facility.

However stringent checks are needed if the problems of “extend and pretend” that had plagued the earlier restructuring schemes are to be avoided.

EBITDA ratios

  • EBITDA is an abbreviation for "earnings before interest, taxes, depreciation, and amortization."
  • The EBITDA-to-sales ratio (EBITDA margin) shows how much cash a company generates for each Rupee of sales revenue, before accounting for interest, taxes, and amortization & depreciation.
  • A low EBITDA-to-sales ratio suggests that a company may have problems with profitability as well as its cash flow, while a high result may indicate a solid business with stable earnings.
  • The ratio excludes the impact of debt interest.

The intercreditor agreement or ICA

  • It is the direct result of the government's Sashakt resolution plan or report on bad banks drafted by the Sunil Mehta committee.
  • The lenders in the agreement will jointly appoint a lead lender who will function on behalf of the entire group.
  • The leading lender will then be required to put forth the resolution plan for the non-performing assets (NPAs) before the group and if it is given a go-ahead by two thirds of the lenders, the proposal will qualify to be taken up for resolution of the given account.

Source: https://indianexpress.com/article/opinion/editorials/cash-strapped-businesses-lockdown-rbi-term-loans-6588434/

Image Source: Economic Times

After reading this article, answer the following question for Mains answer writing practice. Also you can get your answer checked free of cost by clicking on the following link.

For Mains:https://www.jatinverma.org/home/typepost/dailymainsanswerwriting

Q) Reserve Bank of India (RBI) has accepted the recommendations of the expert committee under K.V. Kamath set up to suggest financial parameters for resolution of coronavirus-related stressed assets. Critically analyse the recommendations made by the committee.