On May 5th, 2021, in response to the second wave of the pandemic, the Reserve Bank of India (RBI) re-introduced[1] a loan-restructuring window (Resolution Framework 2.0). Under the framework, lenders are currently allowed to restructure customers’ debts, subject to certain conditions. However, this window under the resolution framework is designated to end by 30th September 2021. Thus, to ensure that the debt distress faced by borrowers is alleviated, it is timely to consider three key questions.
First, should the window under the resolution framework be extended?
Second, is there a need to amend the current regulations?
Third, if there is a need to amend the regulations, how should it be done?
In this blog post, we answer the first two questions. In the next post, we shall present a principle-based approach that the RBI may adopt, thus answering the third question of how the current regulations should be amended or augmented to enhance their efficacy.
- Is there a need to extend Resolution Framework 2.0?
To understand whether Resolution Framework 2.0 should be extended, it is necessary to trace the history of policy measures undertaken by the RBI and their efficacy. During the initial phase of the pandemic, the RBI announced a moratorium on most consumer and small-business debts[2]. In doing so, the policy allowed borrowers to conserve liquidity amidst severe economic shock. Once the 6-month moratorium was over, the RBI provided a “Resolution Framework” (hereafter Resolution Framework 1.0) under which lenders were allowed to restructure borrowers’ debts[3].
This original window lasted for four months, till December 2020 (Q3 FY21), and lenders restructured 0.9% of their overall funded outstanding[4]. To contextualise the quantum of restructuring, during the FY 2020-21, we know that the GDP of India contracted by 7.3%[5]. Similarly, the GVA of labour-intensive sectors like construction, manufacturing, and trade, hotels, transport, communication and services related to broadcasting decreased by 8.6%, 7.2% and 18.2% respectively[6]. It is unlikely that when economic activity reduces by over 7%, less than 1% of the debt held by the actors of the economy comes under distress and needs restructuring.
During this period, the household sector’s debt to GDP ratio stood at 37.3% (FY21), compared to 32.5% in FY20, and 31.7% in FY19[7]. This suggests that coming into the current financial year 2022, households are even more indebted relative to the economic activity in the nation, than at any point in time in the past few years. To worsen the situation, the second wave of the pandemic in the first quarter of the current financial year (FY22), caused major economic disruptions. This is in addition to the residual distress from the first wave of the disease. According to a survey by Azim Premji University, as of October 2020, 60% households were yet to recover from the impact of the pandemic and the lockdown[8]. Similarly, the ILO reports India’s massive informal labour force suffered a 22.6% reduction in wages[9]. Given the residual features of households and the labour force, and the disruptions caused by the second wave, debt serviceability in the economy is likely to have reduced.
Thus, the existence of debt distress is a foregone conclusion.
Further, many parts of the country are currently under lockdowns of varying severity, as the COVID-19 caseloads are increasing. Given these, it is unlikely that all distress caused by the pandemic will become apparent before 30th September 2021, let alone be addressed by then. Thus, it is advisable for the restructuring window to be extended, subject to revision later. Such a policy would be in sync with international best practices[10]. For instance, the Financial Conduct Authority (FCA) of the UK has issued a series of “Tailored Support Guidances (TSGs)”[11] which deal with similar issues that the RBI’s resolution frameworks 1.0 and 2.0 cover. However, unlike the RBI’s policy, the FCA’s TSGs are not time-bound[12]. These guidances, along with the International Monetary Fund’s (IMF) note on “Private Debt Resolution Measures in the Wake of the Pandemic”[13] also provide a blueprint for how optimal policies must be designed and can help us in answering the second question of whether there is a need to amend RBI’s resolution framework.
2. Is there a need to amend the Resolution Framework 2.0?
Broadly, the Resolution Framework 2.0 is a significant step in the right direction, since, under the framework, the RBI moved away from a global moratorium to a more customisable solution to address debt distress. It also addresses a major issue that was present in the first iteration of the framework concerning the transmission of information regarding the restructured status of accounts[14]. However, the framework falls short in two aspects.
First, as discussed earlier, there is a mismatch of timelines. The Resolution Framework 1.0 was designed to provide relief to borrowers undergoing debt distress in the wake of the pandemic. Though the worst of the economic crisis from the lockdown for the calendar year 2020, was over by August 2020 (when the original framework was released), public health experts had constantly warned of a second wave (and a third). Thus, it is safe to conclude, that at the time of implementation of the first framework, the possibility of a second wave of the pandemic was known. Hence, the problem (pandemic) which necessitated the framework was dynamic and had not run its full course, but the policy designed to tackle the issues originating out of the problem was static. The necessity to re-introduce the framework as “Resolution Framework 2.0” indicates that the initial restructuring window was too short to serve its full purpose. As discussed earlier, the current framework too suffers from the same issue. As the possibility of a third wave of the pandemic is high, it may be unwise to put an expiry date on the policy designed to tackle it. Thus, the first amendment should be the removal of the expiry date of the policy.
Second, the framework falls short of its stated objective of “alleviating the potential stress to individual borrowers and small businesses”[15], since it does little to incentivise lenders to offer restructuring. Currently, lenders are faced with two choices. They can choose to offer restructuring resulting in lower short- to medium-term cash flows, while ensuring that assets stay standard (resulting in lower provisioning). Alternatively, the lenders may choose not to offer restructuring, resulting in some assets turning substandard, leading to higher provisions, while other assets continue being serviced by the borrowers. In the first scenario, if the regulator mandates the asset quality to remain unchanged[16], it may lead to a situation where a lender chooses to offer restructuring indiscriminately, leading to moral hazard. In the second scenario, some lenders may choose to not offer restructuring, since lenders may believe that many borrowers will keep repaying even if they are experiencing substantial financial distress. Such a phenomenon, though counter-intuitive, is well-documented, where borrowers, despite being over-indebted, keep repaying[17]. Thus, to effectively combat the debt distress, it is important to amend the regulation and place the onus on the providers to identify borrowers facing financial hardship and offer them a resolution under the framework.
Despite such an onus, lenders may easily offer such restructuring at very high rates of interest, or for very short tenures that are not meaningful enough for the borrower, effectively disincentivising borrowers from availing the remedy. Conversely, the lenders may use the window to not address borrower distress, but to evergreen loans. Thus, apart from extending the restructuring window, and incentivising lenders to restructure accounts of distressed borrowers, there is a clear need for the RBI to issue more detailed guidelines, but not prescriptions, on how such restructuring could occur.
Finally, the third question that we had posed at the beginning of the post remains, “how should the regulation be amended?”. In the next post, we shall present an approach focusing on the key principles that the RBI can consider while designing the restructuring guidelines. In the next post, we also argue that such guidelines must be more exhaustive than the present enabling regulation, and yet, should not be too prescriptive, to ensure that the autonomy of the lender, who is the most proximate to the borrower, is preserved.
[1] See Paragraph-1 of the RBI circular on “Resolution Framework – 2.0: Resolution of Covid-19 related stress of Individuals and Small Businesses” dated 6th August 2020; accessible at: https://www.rbi.org.in/Scripts/NotificationUser.aspx?Id=12085&Mode=0
[2] See RBI’s COVID-19 – Regulatory Package dated 27th March 2020 and May 23rd, 2020; accessible at: https://www.rbi.org.in/Scripts/NotificationUser.aspx?Id=11835 , https://www.rbi.org.in/Scripts/NotificationUser.aspx?Id=11902&Mode=0
[3] See the RBI circular on “Resolution Framework for COVID-19-related Stress” dated 6th August 2020; accessible at: https://rbi.org.in/Scripts/NotificationUser.aspx?Id=11941&Mode=0
[4] See Chart 2.2.c of the RBI’s Financial Stability Report (July 2021), accessible at: https://rbidocs.rbi.org.in/rdocs//PublicationReport/Pdfs/FSRJULY20210595CD3BEDFA466EBE9169BCE426E32C.PDF
[5] See the Annual and Quarterly Estimates of GDP at Constant Prices, 2011-12 Series (released by Ministry of Statistics and Programme Implementation, Government of India), accessible at: http://mospi.nic.in/data
[6] ibid.
[7] See “Household debt jumps to 37.3% of GDP in fiscal 2021, says report”, (The Business Standard, 6th July 2021); accessible at: https://www.business-standard.com/article/economy-policy/household-debt-jumps-to-37-3-of-gdp-in-fiscal-2021-says-report-121070501074_1.html
[8] “State of Working India 2021: One year of Covid-19” (Centre for Sustainable Employment, Azim Premji University, 2021); accessible at: https://cse.azimpremjiuniversity.edu.in/wp-content/uploads/2021/05/State_of_Working_India_2021-One_year_of_Covid-19.pdf
[9] “Global Wage Report 2020-21” (International Labour Organisation, 2021); accessible at: https://www.ilo.org/wcmsp5/groups/public/—dgreports/—dcomm/—publ/documents/publication/wcms_762534.pdf
[10] See: “COVID-19 support measures: Extending, amending and ending” (Financial Stability Board (FSB), April 2021); accessible at: https://www.fsb.org/wp-content/uploads/P060421-2.pdf
[11] See: The Finalised Guidance on “Consumer credit and Coronavirus: Tailored Support Guidance” (January 2021); accessible at: https://www.fca.org.uk/publication/finalised-guidance/consumer-credit-coronavirus-tailored-support-guidance-jan-2021.pdf and the Finalised Guidance on “Mortgages and Coronavirus: Tailored Support Guidance” (March 2021); accessible at: https://www.fca.org.uk/publication/finalised-guidance/mortgages-and-coronavirus-tailored-support-guidance.pdf
[12] Some parts of the TSG that focus on moratorium (payment deferral) are time limited. However, the rest of the sections that focus on restructuring are not.
[13] See “Private Debt Resolution Measures in the Wake of the Pandemic” (IMF, 27th May 2020) ; accessible at: https://www.imf.org/-/media/Files/Publications/covid19-special-notes/en-special-series-on-covid-19-private-debt-resolution-measures-in-the-wake-of-the-pandemic.ashx
[14] See: “Pass Through of Loan Restructuring Information Micro-finance Loans and Credit Bureau Records” (Dvara Research, October 2020); accessible at: https://dvararesearch.com/2020/10/28/pass-through-of-loan-restructuring-information-micro-finance-loans-and-credit-bureau-records/
[15] See the RBI circular on “Resolution Framework for COVID-19-related Stress” dated 6th August 2020; accessible at: https://rbi.org.in/Scripts/NotificationUser.aspx?Id=11941&Mode=0
[16] As was permitted by the RBI in Resolution Framework 2.0. See 16, Reserve Bank of India – Notifications (rbi.org.in)
[17] See: “A Customer-Protection Perspective on Measuring Over-indebtedness” (Jessica Schicks, 2013); Accessible at: https://www.european-microfinance.org/sites/default/files/document/file/Finalist%20Paper_Schicks_I.pdf
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