Pursuant to Relief package announced by RBI vide circular named ‘COVID-19 – Regulatory Package’, for the term loans by all lending institutions (Banks, NBFCs, Financial Institutions), a moratorium of three months have been permitted to be allowed for all installments(principal, interest, bullet repayment, EMIs, credit card dues) falling due between 1 March 2020 and 31 May 2020. Accordingly, the repayment schedule and tenor for such loans would stand shifted by three months.
However this has led many questions unanswered. Queries have been raised to the regulator (RBI) pertaining to several issues (discussed in this article), but in absence of instant guidelines to tide over it, there might be possibility of ripples in the economy. Let’s discuss this
Bill Discounting transactions and Securitization transactions
Bill discounting transactions under TReDS:
Trade Receivables and Discounting System (TReDS) is an electronic bill discounting platform regulated by RBI and endorsed by the central government to provide MSME ‘suppliers’ of corporate ‘buyers’ instant payments for future receivables to prevent delay in payouts for cash-strapped small businesses. Banks and NBFCs finance invoices at competitively priced interest on a bidding basis on the platform, which then gets structured as short-term loans to the corporate with a maximum maturity.
Lenders say these loans don’t qualify as these are neither in the nature of cash credit, nor overdraft. Thus the distressed companies using this platform to discount their invoices are facing potential risk of default as the moratorium benefits are not extended to them.
A method of raising funds wherein an entity (originator) transfers/assigns its receivables (on recourse or without recourse basis) to an SPV (a trust which is created for the purpose of pooling in the Investors money and thereby granting them undivided interest over receivables of the originator in the form of pass through certificates) for building up the liquidity in the form of short/long term funds. The realization from the receivables is to be kept in trust by the originator. Periodically the originator repays the funds to the SPV in installments along with Interest (as specified in the agreement).
Now there is no clarity as to whether installments payable by the entity (originator) to the SPV in this process of Securitization is covered by the RBI circular and whether moratorium is applicable on it.
Post ILFS crisis, when formal lending to NBFCs had been challenging, they resorted to Securitization transactions to keep up the liquidity in the system. Amidst COVID-19
Affecting the entire economy, realization from borrowers/receivables of NBFC is again a herculean task (not to forget the borrowers from these NBFCs are covered by the moratorium). If such transactions are kept outside the purview of RBI circular, there might be possibility of Asset Liability Mismatch (ALM).
Therefore it’s important that Regulator takes right direction in this respect.
Would customers end up paying more post moratorium period?
What if one delays the repayment of EMI for the said period of 3 months?
It has been argued that Interest would continue to accrue on the balance outstanding even if there is moratorium in place for repayment (A petition has been filled in SC challenging this). Thus post the moratorium either the duration of loan may increase or EMI will be increased.
Banks will basically provide 3 options:
1. Onetime payment of Interest that accrues in April and May in the month of June.
2. Add the interest to the outstanding loan and increase the EMI for remaining months.
3. Keep the EMI unchanged but extend the loan tenure.
Irrespective of whichever option a customer selects, he/she will end up paying more. (Source: Economic times)
Battle between two sides over the application of the circular to NBFCs:
The moratorium is not applicable to the loan availed by NBFCs from Banks as the RBI has clarified taking cognizance of this matter that around 4/5th of the NBFCs have healthier financial position to serve the EMIs due. The rest of the NBFCs struggled with cash flow issues even before the rise of COVID-19 due to governance issues.
Certain private and foreign lenders have agreed to defer the installments from NBFCs; however government owned lenders have denied and cleared its stance on not extending the EMI payments of NBFC. This is perhaps a battle of two sides resulting in a tug of war situation for NBFCs
IND AS 109 on Financial instruments dealing with the Expected Credit Losses Model
ICAI Accounting and Audit Advisory (March 2020) came up with the following guidance
“Financial Instruments within the scope of Ind AS 109 such as interalia Loans, Trade Receivables, which are not measured at fair value through proﬁt or loss, are subject to impairment loss recognition and measurement based on an approach called Expected Credit Loss (ECL)
In respect of consideration of any Prudential Regulatory measures taken to sustain the economy such as loan repayment holidays, reduction in interest rates etc., it is important to bear in mind that Ind AS 109, like other the Ind ASs, is a principle based standard and requires application of management judgement. Therefore, prudential regulatory support measures such as temporary repayment moratoriums to tide over the current uncertain economic environment caused by COVID-19 should not be applied mechanistically to reclassify the ﬁnancial instrument into Stage 2 requiring lifetime expected credit losses. This assessment should be made considering all available information about past events, current conditions and forecasts of economic conditions including impact of COVID-19 and Prudential Regulatory measures. As a guiding factor to retain these ﬁnancial instruments in existing category the entities should consider whether the ﬁnancial instruments where repayment moratoriums are granted were regular with no signs of credit deterioration at the me of granting moratoriums and whether these ﬁnancial instruments are expected to remain regular during relief period and thereafter. “
An understanding of the above guidance given by ICAI reveals that a loss allowance (i.e 12 months ECL) on receivables should not be provided if the default is merely due to the circumstances arising due to lockdown period.
However the High Court of Delhi, in its order dated 6 April 2020 (Order) in Anant Raj Limited v Yes Bank Limited, has expressed a prima facie view that an account which has been classified as Special Mention Account-2 (SMA-2 i.e 60 days past due) prior to 1 March 2020 cannot further be classified as a Non-Performing Asset (NPA) for default in payment during 1 March 2020 to 31 May 2020 i.e. the period of moratorium for payment of loan installments, as announced by the RBI.
If entities were to take cognizance of the order (assuming it is not challenged in Apex court), the account would not be classified as NPA even if 90 days past due (DPD) on 1 March 2020 as the status quo has to be maintained on that date.
IND AS 109 further states that,
“An entity shall apply a default definition that is consistent with the definition used for internal credit risk management purposes. However, there is a rebuttable presumption that default does not occur later than when a financial asset is 90 days past due unless an entity has reasonable and supportable information to demonstrate that a more lagging default criterion is more appropriate.”
A literal interpretation of the above Para would mean that an account which is 90 days past due as on the date of circular (or the effective date mentioned in circular i.e 1 March 2020) has to be classified as being in default as on that date unless more appropriate criterion is available. Irrespective of the factors leading to economic downturn arising due to COVID-19, if the repayment history of the borrower presents a strong case of default, it is to be measured at the Expected Credit Losses Model.
What if an account is not classified as an NPA as per the order of High Court but taking the help of the above Para of IND AS 109, in the opinion of Auditor, the account is determined to be significantly credit impaired with a rebuttable presumption of 90 days DPD. This would lead in treating the Loan as Credit Impaired in the Books but may be not be treated as NPA as per prudential regulations. Different treatments/judgments may give rise to further litigations.
SA 560: Subsequent Events
If the court has asked to maintain the status quo w.r.t to the classification of Loan receivables, then post the moratorium period will the subsequent bankruptcy of the borrower prior to approval of financial statements be treated as an Adjusting Event requiring adjustment to the carrying amount of the receivables?. What if there was no default existing as on the balance sheet date (as repayments were stopped following the circular) in order to treat it as an adjusting event. There will indeed be significant judgement involved in this.