Overview

The Reserve Bank of India (RBI), through its notification DBR.BP.BC.No.82/21.04.132/2015-16 dated 25 February 2016,
issued certain revisions and clarifications to its prudential guidelines on
Strategic Debt Restructuring (SDR). It reiterates the requirement for banks to
stringently adhere to previously-issued guidelines including those relating
to:

• triggers for invoking SDR
• effecting a change in the management of borrower companies
• invoking personal guarantees obtained from existing promoters and
• conversion of debt into equity shares of the borrower within the specified timeframe.

In addition, the notification prospectively modifies some of the previously-issued guidelines on SDR as described below.

Significant modifications

Minimum equity divestment to obtain asset classification benefit

This notification states that the minimum quantum of equity to be divested by banks within 18 months to new promoters, in order to retain the benefit relating to the classification of the asset as ‘standard’, has been revised to 26 per cent from 51 per cent previously. Lending banks will have the option of exiting their remaining holdings gradually, with an upside as the company turns around.  However, lending banks will be required to granta ‘Right of First Refusal’ to the new promoters for the subsequent divestment of their remaining stake. 

Timelines for conversion of debt into equity

While the Joint Lenders Forums (JLFs) are required to adhere to the prescribed timelines during the SDR process, the notification permits flexibility in the completion of individual activities up to the conversion of debt into equity in favour of the lenders. However, it requires such conversions to be completed within a period of 210 days from the date a decision to invoke SDR is made (based on a review of the achievement of milestones/critical conditions by the borrower). If this timeline is not met with, the benefit of a ‘standstill’ in the asset classification which was available from the date the SDR was invoked (the reference date) ceases to exist. The loans will then be classified in accordance with the existing ‘Income Recognition, Asset Classification (IRAC) and Provisioning Norms’ prescribed in the RBI’s Master Circular dated 1 July
2015.

Additional provisioning requirements

Previously-issued guidelines on the SDR scheme, as defined in the RBI Circular dated 8 June 2015, exempted banks from the requirement of a periodic mark-to-market of the equity shares of the borrower received on the conversion of debt, for the 18 month period until divestment to the new promoters. The notification now requires banks to periodically value and provide for depreciation on these equity shares as per IRAC norms for investments. However, banks have the option of distributing the depreciation in
value, if any, over a maximum of four calendar quarters from the date of
conversion of debt into equity i.e. the provisioning held for such depreciation
should not be less than 25 per cent of the depreciation during the first
quarter, 50 per cent of the depreciation as per the current valuation during the second quarter, and so on. If banks desire a longer period for making provisions (e.g. six quarters), they can start doing so from the reference date itself.  

In addition, banks are required to ensure that they hold a provision of at least 15 per cent of the residual loan by the end of 18 months from the reference date. This is to avoid a sharp deterioration in the asset classification if the banks are unable to divest a minimum equity stake to new promoters within the stipulated 18 month period. This provision is also to be made in equal
instalments over four quarters and can be reversed only when all the outstanding facilities in the account perform satisfactorily after the transfer of ownership and management control to the new promoters. 

Our comments

Banks and other stakeholders should carefully assess the procedural changes as well as the additional provisioning requirements, which are expected to have a significant impact on banks’ financial statements in the next financial year. While the modified guidelines are applicable prospectively, RBI has encouraged banks to apply them to the existing SDR cases as well. This may have an immediate impact on their financial statements. 

To access the full text of the RBI notification, please click here.