While the systemically important – non-banking financial companies (“NBFC-SIs”) have enjoyed lighter and differential regulation from banks, which has allowed them to operate with flexibility and develop sectoral and geographical expertise, it has also manifested certain concerns in terms of systemic risks. The Reserve Bank of India (“RBI”) has on several occasions expressed its intention to bring NBFC-SIs at par with banks to counter such risks and remove the existing regulatory arbitrage between banks and NBFCs. We have seen several changes in regulation towards this goal, including the scale based regulation for NBFCs that takes effect from October 2022, the large exposures framework applicable to ‘Upper Layer’ NBFCs and a few changes that have also now been included in the latest Master Direction – Non-Banking Financial Company – Systemically Important Non-Deposit taking Company and Deposit taking Company (Reserve Bank) Directions, 2016 (“Master Directions”) in relation to roll-over of loans.
In the past NBFC-SIs were permitted to roll-over short term loans (i.e. loans with a tenor less than one year) (“Short Term Loans”) up to two times without such loan accounts being considered as restructured accounts provided that such roll-over was allowed (i) after conducting assessment of the borrower, (ii) based on the actual requirement of the borrower and (iii) where no concession has been provided due to credit weakness of the borrower. In case a Loan was rolled over more than two times, the account was to be treated as a restructured account from the third roll-over of the Loan. However, with effect from March 03, 2022, this exemption (permitting roll-over of Loans by NBFC-SIs in certain circumstances) is no longer available basis the latest Master Directions. Any roll-over by an NBFC-SIs would now need to be considered from a ‘restructuring’ perspective.
As per the circular on the Prudential Framework for Resolution of Stressed Assets issued by Reserve Bank of India dated June 07, 2019 (“Stressed Assets Circular”), where any NBFC restructures a ‘standard’ account, such account is to immediately upon restructuring, be downgraded as non-performing assets, i.e., sub-standard to begin with and such NBFC would need to accordingly comply with provisioning requirements for such sub-standard account. The Stressed Assets Circular defines restructuring to mean “an act in which a lender, for economic or legal reasons relating to the borrower’s financial difficulty, grants concessions to the borrower. Restructuring would normally involve modification of terms of the advances / securities, which would generally include, among others, alteration of payment period / payable amount / the amount of instalments / rate of interest; roll over of credit facilities; …”
Considering roll-over of a loan is specifically addressed in the definition of ‘restructuring’, any roll-over, which is granted as a concession for economic or legal reasons relating to the borrower’s financial difficulty, would likely be construed as ‘restructuring’. NBFC-SIs will therefore need to consider undertaking enhanced diligence prior to granting any roll-over of Loans to ensure that the same is not driven by or resulting out of financial difficulty of the obligor, thereby amounting to ‘restructuring’. NBFC-SIs are in any event required to formulate a detailed policy on the various signs of financial difficulty, providing quantitative as well as qualitative parameters for determining financial difficulty, similar to policy expected of a prudent bank.
There is a market perception that NBFC-SIs have not been given the benefit of a transition period which would have enabled the alteration of existing practices on roll-overs. However, in our view things are not all doom and gloom. The “two roll-over exemption” was never a blanket wavier of the diligence requirements. Even prior to the change, roll-overs could be only basis borrower requirement, after due assessment of the borrower to ensure no concessions due to credit weakness. In such cases, a third roll-over was automatically categorized as a restructured account. This presumption of restructuring has now fallen away and could be the silver lining for both NBFC-SIs as well as borrowers for additional roll-overs where there is no financial difficulty.