On 5 May 2017, a day after the recent Banking Regulation (Amendment) Ordinance, 2017 (Ordinance) received Presidential assent, the Reserve Bank of India (RBI) issued a circular on ‘Timelines for Stressed Assets Resolution’ (Circular). The Circular amends the existing “Framework for Revitalising Distressed Assets in the Economy – Guidelines on JLF and CAP” dated 26 February 2014 (JLF Framework) and mandates members of a joint lenders forum (JLF) to follow strict timelines in implementing the corrective action plan (CAP) or suffer penal consequences for non-compliance.

This Circular has been issued against the backdrop of the Ordinance which empowered the RBI to, inter alia, direct banks to initiate insolvency proceedings and issue directions for resolving stressed assets. The Circular constitutes the first set of directions issued by the RBI under the Ordinance, and clearly demonstrates that the RBI is exercising its powers under the Ordinance to achieve successful resolution of stressed asset situations.

Brief Background of the JLF Framework

The JLF Framework was formulated by the RBI with the objective of enabling lenders to identify stressed assets at an early stage and arrive at a feasible solution for timely restructuring of stressed accounts or dispensing with unviable accounts before such accounts are declared as non-performing assets. The JLF Framework sets out inter-alia detailed guidelines on:

  • segregation of accounts under three categories of ‘special mention accounts’, basis their principal and interest overdues;
  • formation of JLF and adoption of CAP for operationalisation of the JLF Framework;
  • minimum consent requirements of the members of the JLF for agreeing on a restructuring process and timelines for decisions by lenders; and
  • implementation of the agreed CAP (for instance, JLFs were required to evaluate the restructuring package to be adopted for CAP within 45 days of an account being reported as SMA-2 and to implement the approved package within 90 days of approval).

This however did not achieve the desired effect as there were disagreements amongst lenders with respect to each of their individual accounts and delays in the decision making process for the CAP. In the Circular, the RBI has observed that while the JLF Framework required each member of the JLF to implement the CAP in a time bound manner and scrupulously adhere to specified timelines, failure by the lenders to effectively implement the CAP within the agreed timeframe has largely defeated the very purpose of the JLF Framework for initiating prompt corrective measures in cases of stressed accounts.

Amendments under the Circular

The key features of the Circular are set out below:

  • Minimum votes slashed: While the extant JLF Framework stipulated consent of a minimum of 75% of creditors by value and 50% of creditors by number in the JLF for the basis of a binding restructuring process, the quantitative criteria for deciding and approving the CAP has been reduced to a minimum of 60% of creditors by value and 50% of creditors by number. This decision would be binding on all members of the JLF. With this amendment, the RBI has departed from the 75% majority lender consent benchmark that is widely accepted in market practice and continues to exist under key regulations like the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 and the Insolvency and Bankruptcy Code as well as the Corporate Debt Restructuring Framework. The reduced minimum voting percentage will help to expedite the decision making in the JLF and prevent individual banks from derailing the resolution process.
  • Lenders representatives to be clearly mandated to implement CAP: Lenders are required to ensure that their representatives in the JLF are equipped with appropriate mandates and that decisions taken by the JLF are implemented within the timelines agreed under the CAP. This is to avoid lender representatives causing delays by citing lack of authority to sign off on key decisions for the CAP.
  • Clubbing of various restructuring mechanisms under the CAP: While the Framework provides for broadly three options under the CAP, viz  (1) rectification or regularisation of the debtor’s account to bring it out of its SMA status, (2) providing need-based additional financial assistance as a part of the rectification process and (3) a recovery process and restructuring process, the Circular clarifies that the CAP can also include resolution by way of flexible structuring of project loans, change in ownership under the strategic debt restructuring and scheme for sustainable structuring of stressed assets (S4A). This clarifies the uncertainty as to whether the restructuring modes issued under various RBI circulars could be combined for efficacious resolution.
  • Unconditional nature of vote for banks with no additional conditionalities allowed to be imposed: The Circular imposes unconditional obligations on the participating banks to comply with the agreed CAP with no scope for any change in conditions or ambiguity and therefore confers the much-needed finality to an approved CAP, eliminating the possibility of banks causing roadblocks even after the CAP has been finalized.
  • Monetary penalties under Banking Regulation Act, 1949 (as amended): The extant JLF Framework stipulated disincentives for banks like asset classification and accelerated provisioning requirements without providing any severe penal consequences for non-compliance. The Circular now stipulates that the non‑compliant banks may be subject to monetary penalties of the higher of one crore rupees or twice the amount involved in such contravention and for a continuing contravention, a further penalty of one lakh rupees may be chargeable for the time during which such contravention or default continues.
  • Bank executives can implement JLF decisions without going back to the board: The Circular empowers banks to bypass Board approval for implementation of the CAP and can now depute their bank executives for deliberations and final decision making thereby reducing the bureaucratic challenges faced by many banks in obtaining internal authorizations.
  • Exit option given to banks who do not agree with majority decision: Any dissenting lender who does not agree with the JLF’s decision will have the option of exiting their exposure completely by selling their exposures to a new or existing lender within the prescribed timeline for implementation of the agreed CAP.

Given the mounting NPAs in the Indian banking sector, the Circular is an aggressive yet efficacious move by RBI in the right direction. Under the current scenario where the Indian economy is burdened with challenges of bad debt and stressed accounts of 135 per cent from Rs 261,843 crore in the last two years, this move by the RBI is a panacea for the banking sector. The Indian banking sector lying under a bell jar of regulations on restructuring and stressed assets can now heave a sigh of relief given that the multifarious modes of resolution like flexible structuring of project loans, change in ownership under the strategic debt restructuring and scheme for sustainable structuring of stressed assets (S4A) can be a part of the CAP. Further, the unconditional voting requirement by banks without the option to reverse its decision or attach post consent conditionality will substantially fast track the process. The monetary penalties for non-compliance will make banks more conscious of their decisions and accountable for their actions. The penal consequences may also serve to give teeth to other similar RBI directives which do not contain express monetary penalties.

Khaitan Comment

The Circular will definitely further the JLF Framework’s key objective of speedy implementation of the JLF decisions and preservation of the economic value of stressed assets. The effectiveness of the Circular however, like any other regulatory policy, would have to be put to a severe test. There is nothing to suggest that the Circular would apply retrospectively. However, banks have been advised to take similar action for past cases. It is also pertinent to note that the RBI has issued this Circular exercising its powers under the Ordinance which are limited to directions to ‘banking companies’ (public sector and private sector banks) and does not extend to non-banking finance companies (NBFCs) which are also heavily burdened with rising level of unrecovered loans. In this context, the RBI would need to issue separate clarification for NBFCs given that the JLF Framework also applies to NBFCs. There is also some lack of clarity as to whether the reduced voting percentages under the Circular would also apply in case of majority decision making under the SDR or S4A guidelines – this should be seamlessly aligned to avoid contradictions.