A “black swan event” such as the current COVID-19 crisis is beyond the risk management capabilities of financial institutions as well as regulators such as central banks that oversee them. In such situations, it is sensible for regulators to provide a certain degree of flexibility to allow financial institutions to continue to function so that they do not seize up. Such moves also provide confidence to the financial sector and curtail bear market tendencies.
On 27 March 2020, the Reserve Bank of India (RBI) announced certain relief measures in its circular titled COVID-19 – Regulatory Package. The circular provides relief in respect of all instalments (principal and interest) of term loans, including agricultural, retail, and crop loans, and working capital facilities in the form of cash credit and overdraft facilities provided by commercial banks, small finance banks, local and regional banks, co-operative banks, all-India financial institutions, non-banking financial companies and housing finance companies that are due between 1 March and 31 May. Lending institutions are permitted to provide a moratorium in respect of instalments on these loans by extending the tenure of such loans for the period of the moratorium. The interest in respect of such loans will continue to accrue for the period of the moratorium. Lending institutions are also permitted to defer the interest payments of working capital facilities, including cash credit and overdraft facilities due between 1 March and 31 May, and to recover the accumulated interest immediately after 31 May. Lenders are required to frame policies prescribing objective criteria for considering the grant of the reliefs contemplated by the circular.
The RBI has also clarified that any forbearance provided under the circular “will not be treated as concession or change in terms and conditions of loan agreements due to financial difficulty of the borrower”, and “shall not result in asset classification downgrade”. This means that any asset classification changes shall be determined on the basis of the revised repayment schedule. Lenders also need not treat such rescheduling of interest and other payments as a default for the purposes of supervisory reporting. Considering that asset classification triggers provisioning requirements, which in turn directly impacts a lender’s balance sheet, this is a far-sighted move which will incentivize lenders to offer moratoriums under the circular.
The circular applies only to loans provided by the lenders, and does not specifically apply to other forms of financing such as non-convertible debentures or any off-balance sheet transactions. Further, the circular does not apply to financing obtained by Indian borrowers from entities that are not regulated by the RBI. Such lenders would include financial institutions regulated by the Securities and Exchange Board of India (SEBI) such as mutual funds and alternative investment funds. Given that most borrowing profiles tend to be diversified, and include borrowing from the capital markets as well as indebtedness from conventional bank sources, it would be useful if SEBI were to consider permitting entities regulated by it to offer a similar moratorium. While a moratorium does present some risk of hazard, it avoids the undesirable outcome of financial contagion caused by the absence of capital markets as a source of financing. Notably, the Insurance Regulatory and Development Authority of India has allowed insurance companies to grant a moratorium to borrowers of term loans on similar lines as that prescribed by the RBI.
The circular is a commendable measure to alleviate financial stress caused by the COVID-19 crisis. However, it has the obvious disadvantage of being applicable only to a specific category of lenders and does not apply to sources of financial indebtedness such as the capital markets that are not directly regulated by the RBI. To fully implement the intent of the circular, other financial sector regulators would also need to prescribe similar measures or alternatively prescribe other measures, such as the easing of valuation or asset classification requirements that would provide relief to borrowers. While the RBI can take the first step in situations like this in its capacity as India’s oldest regulator, other regulators and the Ministry of Finance should also move in a coordinated manner and in lock-step with the RBI.
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