Attempt at Easing Out the NPA Crisis: An Analysis of the RBI’s Reform Efforts

[The following
post is contributed by Neelasha Nemani,
who is a 5th year student at National Law University Odisha (NLUO),
The “bad loan crisis” that has gripped
India’s large banking sector didn’t just happen overnight. This problem has
long since been the elephant in the
room; in other words, it has been the most obvious impending risk that
neither the legislature nor the regulator seemed to have acknowledged until it
got much worse. This post seeks to delineate the efforts of the Reserve Bank of
India (“RBI”) in easing out the
current crisis, with particular focus on an analysis of its Strategic Debt Restructuring
Scheme, 2015 (“SDR”) and the
Sustainable Structuring of Stressed Assets Scheme, 2016 (“S4A”).
The SDR Scheme
In 2014, the RBI introduced the Framework
for Revitalising Distressed Assets in the Economy – Guidelines on Joint
Lenders’ Forum and Corrective Action Plan, 2014
in which a change of
management in the stressed borrower company could be envisaged as a restructuring
plan to assist lenders in their attempt to recover bad loans. In line with
these guidelines, the RBI on June 8, 2015, introduced the SDR Scheme according
to which a consortium of lenders, also known as Joint Lenders’ Forum (“JLF”), converts a part of its stressed
loan in the ailing borrower company into equity, with the consortium owning at
least 51% stake in the company.[1]
This scheme essentially seeks to give
banks the opportunity to take over the management of the ailing company and
turn it around to make it a viable project within 18 months, after which it
would sell its stake to a new promoter. Banks, through this form of
restructuring, seek to realize their stressed assets, since the asset can be
re-categorized as a Standard Asset[2]
once its stake in the company has been sold. The scheme also provides for a regulatory
to the banks during this 18-month period wherein:
1.         The bank is not required to observe the
requisite provisioning norms[3] to
support the asset undergoing reconstruction, thereby retaining existing cash
2.         The bank is permitted to charge the
interest earned from the reconstruction on accrual basis[4]
and will not have to wait until it is actually realized.
However, while theoretically speaking
this scheme may have been envisaged as a solution to the growing problem of Non-Performing
Assets (“NPAs”), it also comes with
its own set of problems as far as its practical implementation is concerned:
1.         The 18-month window given to the banks
is too short a period within which the bank could be expected to efficiently
run the business and manage its restructuring as well as find a new buyer. The
banks’ tasks include valuing the company, converting part of its debt into
equity, preparing a restructuring plan for an overhaul, etc. Simultaneously, they
also have to work on identifying a new promoter who itself, for the purpose of
acquisition, will have to conduct its own due diligence of the company, conduct
valuation, complete the requisite formalities in respect of the acquisition,
etc. For all of this to be completed successfully within 18 months seems quite

The downside of
this scheme is that if the lenders are unsuccessful in selling their stake and
exiting the company within 18 months, the regulatory relaxations discussed
above cease to exist and the banks will be required
to comply with the provisioning requirements
for the total outstanding debt
with retrospective effect, from the date of the first restructuring, in one
quarter. Needless to say, the SDR route is not advisable if the banks are not
certain of being able to sell their stake within the said 18-month period.
Further, the scheme does not provide for a partial sale either. Hence, trying
to find a buyer for a majority stake in an ailing company, especially within
such a short period, is very difficult. The scheme also requires that the
promoter should be unrelated to the original promoter or promoter group of the
company, thereby adding to the complexity.

As a response
to this criticism, the
RBI has recently amended the requirements
, providing that the banks will no
longer have to sell their entire 51% stake in order to upgrade the status of
the concerned asset to a Standard Asset, and will only have to sell 26% of
their stake to a new promoter.

2.         Due to their lack of expertise, banks
find it extremely difficult to engage in the management of companies.
Therefore, it has been seen in most cases that they continue with the existing
management of the borrower company and only exercise external supervisory
control over the affairs of the company, making it less attractive for a new
3.         Upon acquiring the controlling stake of
51% in a listed company, the new promoter will be required to make an open
offer of 25%. If the open offer is fully subscribed to, the buyer will be the effective
holder of 76% stake in the company, triggering the delisting of the company due
to SEBI’s minimum public float requirements. In such a situation, no new
promoter would be encouraged to purchase the 51% stake in the company owing to
the fact that delisting would impact the promoter’s liquidity. While banks have
been given the exemption of having to delist the company, new promoters have
not been provided this comfort.
that out of the total 21 cases of SDR that were invoked, only two
were successfully closed in the last 14 months since the inception of this
Scheme. Due to the above problems, it has been pointed out that this scheme
only causes an ever-greening of NPAs by delaying their re-categorization into
NPAs by a few years and will not actually solve the issue at hand.
The S4A Scheme:
In order to further strengthen the
lenders’ ability to deal with bad loans, the RBI had, on June 28, 2016,
introduced the S4A
alongside the SDR scheme. According to these guidelines, banks can
bifurcate the debt of the borrower into two portions – the sustainable portion
which would be based on the debt servicing capability of the borrower company
(classified as a Standard Asset), and the unsustainable portion which would be
linked to equity or quasi equity instruments. An Overseeing Committee would be
set up by the Banks’ Association, in consultation with the RBI which will
review the process and act as an advisory body.
The positive aspects of S4A over the
SDR are several, some of which are:
1.         Banks do not have to find a new
promoter to buy their stake in the stressed company and the existing promoters are
allowed to continue. This acts as an incentive
to the promoters to turn the company around
and consequently the banks can
benefit out of such equity valuation.
2.         Banks are permitted to hold optionally
convertible debentures instead of equity shares in the company, which is always
more preferable.
3.         The entire debt portion does not have
to be converted into equity, as under the SDR scheme. Since only the
unsustainable portion of the debt is required to be converted into equity, some
bankers are of the opinion
that operations will be able to be managed more
smoothly and there would be a more realistic chance at recovery of the loan.
However, here are some glaring problems
with this scheme that may question its viability:
1.         The S4A does
not allow banks
to offer any moratorium on debt repayment and also does not
allow amendments to the repayment schedule or even a reduction of interest
2.         Unlike under the SDR, there is no
relaxation to banks in respect of the provisioning requirement. Therefore, banks
will be required to maintain a minimum 20% provision of the total loan amount
outstanding or 40% of the unsustainable portion of the debt at the time of
initiation of the scheme. The banks will also have to provide for 100% of the
expected losses on the unsustainable portion over the period of four quarters,
over and above the 20%-40% requirement.[5]
3.         Only projects that have started
commercial production can take advantage of this scheme.[6]
Therefore, infrastructure projects that may have been stalled due to delay in
regulatory approval cannot be invoked under this scheme.
4.         The presumption that conversion of debt
into equity is the cure for all ills has not proven to be true in a lot of
cases. Equity is a perennial liability and is a costlier mode of finance
compared to debt capital which at least has tax benefits. If a project does not
seem to be sustainable, this route is not a viable option.
5.         Under the existing framework of the
scheme, only the existing cash flows at the current level can be used to
determine the debt servicing capability of the company. This mandate received
much flak from bankers
across the country because they identified that a
good number of companies were not operating at their optimal level currently
and were therefore unable to make the cut for initiating this scheme.
While the S4A may have theoretically
addressed the fallacies that were present in the SDR scheme, the viability of
this scheme nonetheless seems questionable to bankers.
– Neelasha Nemani

[1] Sanjay Israni and Rajashree Ravi, India: Strategic Debt Restructuring, Mondaq, October 25, 2016, available at

[2] Explanation: A ‘Standard Asset’ is an asset which is not a Non
Performing Asset as defined under section 2(o) of the SARFAESI Act, 2002.

[3] The ‘Provisioning Norms’ referred to here have been detailed in the
RBI Master Circular on Prudential Norms on Income Recognition, Asset
Classification and Provisioning Pertaining to Advances, 2013.

[4] Interest from a Non Performing Asset is required to be recorded on
receipt basis as opposed to interest from a Standard Asset which is recorded on
accrual basis. For details, refer to the above Provisioning Norms.

[5] RBI, Notification on Scheme for Sustainable Structuring of Stressed
Assets (Guidelines), June 13, 2016.

[6] Id., at para 4.

About the author

Umakanth Varottil

Umakanth Varottil is an Associate Professor at the Faculty of Law, National University of Singapore. He specializes in corporate law and governance, mergers and acquisitions and cross-border investments. Prior to his foray into academia, Umakanth was a partner at a pre-eminent law firm in India.

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