RBI Deadline Extension: A Welcome Relief for NBFCs and Borrowers
Deadline extended for NPA recognition standards, loan upgrade will protect NBFC results
By YS Chakravarti
Non-Banking Financial Companies (NBFCs) play a vital role in the Indian economy by providing access to funds to the last mile customer. NBFCs have provided credit of a large nature, amounting to more than 26 lakh crore to individuals and various industries in September 2021. Credit growth, below 10% in December 2021, indicates sluggish credit demand. While the green shoots of recovery are visible in some sectors, small businesses are not yet out of the woods.
The government and the RBI have taken several measures such as interest subsidy and credit guarantee schemes, special liquidity windows and long-term repo operations to support the MSME sector. However, these sectors need continued regulatory support, including easy access to cheap credit, to help them weather cash flow disruptions.
In this context, RBI’s decision to extend the implementation deadline of its November 2021 circular on the recognition of non-performing loans by NBFCs is a relief. This will give breathing space to NBFCs’ bottom line, give them more time to implement the new systems and processes, and also put less pressure on borrowers‘ credit profiles. In accordance with the circular, NBFCs must recognize APMs daily on the due date. They can upgrade an account from “NPA” to “standard” only on payment of all arrears, including interest. This will align NBFC standards with those of banks. The deadline has now been extended to September 30, 2022.
RBI also clarified that the exact repayment due date, repayment frequency, break between principal and interest, and examples of special mention dates or NPA classification should be clearly specified in the loan agreement. . In addition, in the case of loan facilities with a moratorium on the payment of principal and/or interest, the exact date of the start of repayment must also be specified.
Previously, industry practice was to book distressed loans on a period-end basis and upgrade loans even when partially paid. The combination of end-of-day recognition and tougher standards for loan upgrading means that NBFC distressed loans are likely to be classified as NPA sooner and remain as NPA longer, until the new collection mechanism is in place.
The recent extension is a positive step for both borrowers and lenders; however, the extension would have been much more useful had it been accompanied by RBI’s November 2021 circular, in which RBI revised the NBFC framework to classify loans as “standard” or “NPA” in line with recognition standards Income and Asset Classification (IRAC) .
In Q3FY22, most NBFCs absorbed the impact of RBI standards, taking a hit of around 100 to 300 basis points on their GNPAs; thus, the clarification only postpones the adoption of the new standards. In addition, NBFCs are unlikely to reverse already existing provisions, due to accounting complexities. Until the gap between the old and the new NPA methodology is reduced, it will not seem appropriate to reverse the provisions. The hit from the revised standards has been higher for NBFCs lending to economically weaker individuals, small businesses and vehicle financiers, due to erratic repayment behavior by small borrowers and cash flow disruptions.
On the client side, individual entrepreneurs and MSMEs, below a certain amount of outstanding exposure, should be fully exempted from the new classification standards, as their cash mismatches are generally long-term.
Furthermore, the standards came just as NBFCs were seeing a smoothing out of cash flow driven by a gradual economic recovery. Even if collection efficiency improves across the industry, these standards may offset gains in portfolio quality and provisioning requirements, resulting in stagnant or slightly higher. NPA industrially in the short term. However, six months from now, due to the positive fallout from the budget’s capital spending, the economy could be doing much better and delinquencies could start to drop.
The NBFC industry has requested a further extension until March 2023, exemption of MSME loans, auto loans up to 25 lakh and personal loans up to 2 crore, at least until the terms economies return to the pre-pandemic state. Any easing will lead to a healthy overall recovery for the industry. As such, provisioning requirements for most lenders are not expected to increase as NBFCs follow the Ind-As accounting standard, in which provisions are based on expected credit loss.
However, the gap between Tier 3 assets and NPA ratios may take some time to narrow given the short-term spike in bad debt. The NBFC industry will work to strengthen collection efforts and processes in the 0-30 and 31-60 day backlogs to avoid account downgrades and control asset quality. This will be beneficial in the long term as it will enable better overall portfolio quality for individual companies and the sector, increased focus and innovation in collection processes, and encourage better credit discipline from borrowers.
The author is MD and CEO, Shriram City Union Finance