Prudential Framework for Resolution of Stressed Assets

Profile of Author : Priya Mishra is a 3rd year law student pursuing B.B.A LL.B from MMDU, Ambala. Corporate Law, Company Law, and ADR hold her keen interests.

INTRODUCTION

The Reserve Bank of India circulated a revamped prudential structure for resolution of stressed assets ( "Prudential Framework” ) on 7 June 2019 reconstructing the former circular on Resolution of Stressed Assets dated 12 February 2018. The RBI introduced the Reserve Bank of India Directions 2019 implementing fresh directions to lenders on the resolution of stressed assets. The added provisions support both informal and formal restructuring in India.

The RBI at the time of issuance also issued a press release in the purpose clause of the Revised Circular clarifying that “Notwithstanding anything contained in this framework ( Revised Circular), wherever necessary, RBI will issue directions to banks for initiation of insolvency proceedings against borrowers for specific defaults so that the momentum towards effective resolution remains uncompromised.”[1]

It aims to address the concerns raised by the Supreme Court of India in the Dharani Sugars judgment. In the case of Dharani Sugars and Chemicals Limited v. Union of India [2], the Supreme court struck down the prior framework in its Judgment, on the ground of being ultra vires section 35AA of the Banking Regulation Act, 1949 [3] dated April 2, 2019. Thus, all the actions under the former structure became null and void. It's been implemented to guarantee the betterment of a robust and resilient financial system. Also, to strengthen and advance the credit culture in India.

The new guidelines contain several relaxed norms. The Reserve Bank of India ( RBI ) has come with a new framework, in form of Directions, with enhanced applicability covering banks, financial institutions, small finance banks, and systematically important NBFCs.

Though several changes were made but to accommodate the verdict of the supreme court, the following Corrections were made under the new Prudential Framework :

1. Banks have the choice to go/or not to go for insolvency on corporate default.
2. RBI will give directions on specific defaults in the future based on the Prudential framework of 2019.

Unlike the previous revised framework ( 12th Feb 2018 ), The Prudential framework has a more comprehensive scope for discretion to lenders, gives deliverance to the members of the joint lenders’ forum consisting of banks, financial institutions, small finance banks, and systemically important NBFCs, to decide the resolution plan.

APPLICABILITY

The Prudential Framework shall apply to

• Scheduled Commercial Banks (SCB),
• All India Term Financial Institutions (AITFI),
• Small Finance Banks (SFB),
• NBFC-ND-SI, and NBFC-D.

It does not apply to regional Rural Banks, FCCB Holders, etc.

RESOLUTION PLAN

• Lenders are obligated to adopt required policies to draw the indications of financial trouble and set out qualitative and quantitative criteria for the determination of such financial trouble.
• Lenders have been provided in compliance with the type of resolution plan that they may propose. The policies incorporate the sale of debt, change in ownership, regularisation of the accounts, and restructuring.
• Independent Credit Evaluation (ICE) by credit rating agencies (CRAs) specially permitted by RBI is one of the essential conditions that have been specified for the implementation of a Resolution Plan.
• To implement a resolution plan, all lenders are compelled to enter into an Inter Creditor Agreement (ICA) during the Review Period. All decisions when made with the consent of 75% by value of the total outstanding credit facilities and 60% of lenders by number will binding all lenders. Any dissenting lenders under the RP are required to be paid at least the amount which they would receive on liquidation.
• Initiation and Implementation of Effective measures to a resolution plan even before an error has occurred are demanded from lenders. If the lender is an SCB, SFB, or AITFI, and the failure has occurred then they are obliged to initiate a prima facie review of the borrower within 30 days of such default (Review Period).
• The resolution plan should grant those dissenting lenders will not get less than the liquidation value due to them.
• The structure also affirms that it may provide for the responsibilities of lenders and guard the rights of disagreeing lenders and treatment of lenders with preference in cash flows or differential security interest.

IMPLEMENTATION OF RESOLUTION PLAN

The implementation only is done, if the following conditions are met [4] :

• Where there is no restructuring or change in ownership under the Resolution Plan:

If the borrower has not defaulted with any of its lenders as on the 180th day from the end of the Review Period.

• Where there is a restructuring or change in ownership:

(i) when all records and documents are duly executed between the parties.

(ii) the new capital hierarchy is indicated in the books of both, the lender and the borrower.

(iii) the borrower is not insolvent with any lenders.

• Where the Resolution Plan involves an assignment of exposures or recovery action:

The exposure to the borrower is fully extinguished.

PRUDENTIAL NORMS

The key norms are as follows –

1. Asset classification
2. Additional finance
3. Interim finance
4. Conversion of principal into debt equity
5. Change in ownership
6. Sale and leaseback transactions
7. Refinancing of exposure to

borrowers

1. Regulatory exemptions ( SEBI )

FEATURES

• Loan insolvency has to be comprehended within 30 days. The lenders have the prudence to commence lawful proceedings for Insolvency.
• Lenders will undertake a Prima Facie Review of the Borrower Account within thirty days from such default.
• If the RP has to be carried out, the lenders will enforce an Inter Creditor Agreement (ICA) as they will provide the basis for finalization and execution of the policy with credit facilities.
• The residual debt has to be evaluated if the RP entails Restructuring in Ownership in respect of accounts where the aggregate orientation of lenders is ₹ 1 billion and above.
• An Independent Credit Evaluation (ICE) of the residual debt shall be carried out by Credit Rating Agencies (CRAs) who are Authorized by Reserve Bank of India (RBI) for this purpose

INTERFACE WITH SEBI REGULATIONS

Transformation of debt into equity shares that are attained in consonance with the New Framework will be spared from the applicability of preferential matter provisions under the Securities and Exchange Board of India Regulations, 2018 and from open offer regulations under the Securities and Exchange Board of India Regulations, 2011, provided that the matter of shares complies with pricing approaches under the New Regulations.

CONCLUSION

The Reserve Bank of India focuses on the time-bound resolution by providing an effective revised framework for the perseverance of stressed assets. The resolution is credit positive, because it brings the focus on the necessity for the rapid resolution of such assets, and the hype of loan loss equipping against those assets. It provides full flexibility to commercial banks out there. The prudential framework provides incentives and disincentives and strikes a right symmetry in between consensual and in-court restructuring under the Insolvency and Bankruptcy Code (IBC).

FAQ

1.Is the Resolution Framework applicable to all exposures, incorporating investment exposures that are credit reserves like corporate bonds, commercial papers, etc.?

• Resolution Framework is without bias to all applicable guidelines issued by the relevant financial sector regulators and other Departments of the RBI in respect of any particular exposure.

1. Are the various additional provisions prescribed in the Resolution Framework applicable to NBFCs who are following IndAS?

• NBFCs which are required to comply with Indian Accounting Standards shall continue to be guided by the guidelines duly approved by their Boards and as per ICAI Advisories for recognition of a significant increase in credit risk and computation of Expected Credit Losses.

[1] https://www.southindianbank.com/UserFiles/file/SEF_332.pdf

[2] https://indiankanoon.org/doc/15876695/

[3] https://rbidocs.rbi.org.in/rdocs/Publications/PDFs/BANKI15122014.PDF

[4] https://www.lexology.com/library/detail.aspx?g=52d1018a-8216-487d-a036-2ed55d6a75a4

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