– Anita Baid, email@example.com
(Updated as on 24.04.2020)
Due to sudden out-break and spread of COVID-19 across the globe, economic condition of the financial service sector has been adversely affected. In this regard RBI has issued several guidelines and advisories and brought into place regulatory polices to give benefit to the borrowers to ease the financial crisis. The Reserve Bank of India in its Statement of Development and Regulatory Policies dated March 27, 2020 has permitted banks and non-banking financial institutions to provide a moratorium to borrowers for a period of 3 months. Thereafter, the RBI came up with a notification titled COVID 19 Regulatory Package providing a brief guideline about the relaxation. This was followed by the FAQs on RBI’s scheme for a 3-month moratorium on loan repayment issued by the Ministry of Finance.
However, there are still certain issues that are not clear and due to the ambiguity around such issues, banks and NBFCs have been making their own interpretation. One such major issue was with respect to the grant of moratorium to loan accounts having over dues as on March 1, 2020.
Regulatory Package by RBI
Before examining the issue let us understand that the underlying objective of the RBI’s guidelines was to inter-alia ease the financial stress caused by COVID-19 disruptions by relaxing repayment pressures and improving access to working capital. The COVID -19 Regulatory Package provides for rescheduling of the payments in respect of term loans and working capital facilities.
Several contentions have been raised stating that the moratorium is not applicable to the borrowers who are already in default as on March 1, 2020. The argument to support this contention is that the language of the Regulatory Package clearly states that the three month moratorium is applicable only to those instalments which fall due between March 1, 2020 and May 31, 2020. Accordingly, only those borrowers would be covered whose loan account is outstanding as on March 1, 2020 and were properly servicing their account till that date and were not in default.
This was further supported by a clarification issued by letter dated March 31, 2020 by the Chief General Manager-in-charge, Department of Regulation of the RBI to the Chairman, Indian Banks Association, wherein it stated that if a borrower has been in default even before March 1, 2020, such default cannot be said to be as a result of economic fall due pandemic and benefit of moratorium can be extended to such borrower in respect of payment falling due during the period March 1, 2020 to May 31, 2020. However, payments overdue on or before February 29, 2020 will attract the current Income Recognition and Asset Classification Guidelines (IRAC Guidelines).
Such an approach will cause all past due accounts to become NPAs during the disruption period, and therefore, the regulatory recognition of the disruption period as not a case of contractual failure but a case of systemic failure, gets defeated. The relaxation or grant of moratorium presumes that during the period of March 1, 2020 to May 31, 2020, the borrower has not paid due to a systemic disruption. If the logic of disruption applies to the current dues during the moratorium period, the same logic cannot be inapplicable for the past dues.
For example, a borrower had payments due on February 29, 2020 which was 30 DPD. In case he cleared all his dues, say on 31st March, his account, which was, say, 60 DPD on 29th March, would have been a regular standard account. But the borrower was precluded from paying anything during the disruption period. Thus, the opportunity of clearing any past due payment is not available to the borrower during the period of disruption. What is a “default” on 1st March, 2020 continues to be a default, but the ageing of the default cannot increase during the disrupted period. The disruption is not a credit event, perhaps, it is an externality, and admittedly a force majeure. Therefore, the disruption causes a standstill on the obligations of the borrower.
The period of disruption is a period during which the clock of the payments in the system stops. If the ageing of past receivables changes, then the disruption will cause all regular accounts to become irregular. In such a case even a 10 DPD on February 29, 2020 will become an NPA around May 19, 2020. Such an approach will cause all past due accounts to become NPAs during the disruption period, and therefore, the regulatory recognition of the disruption period as not a case of contractual failure but a case of systemic failure, gets defeated.
Delhi High Court Ruling
The recent judgement of the Hon’ble Delhi High Court in the case of Anant Raj Limited Vs. Yes Bank Limited dated April 6, 2020 has given a different perspective to the entire situation.
The matter of dispute was the asset classification of the petitioner. The petitioner’s instalment that was due on 01.01.2020 was not paid within 30 days, due to which the account was classified as SMA-1 and thereafter since it was not paid within 60 days, the account was classified as SMA-2. Further, it was contended that since the instalment was not paid till 31.03.2020, the account of the petitioner was liable to be classified as NPA.
The court considered the fact that in view of the pandemic COVID-19, RBI has issued several guidelines and advisories and brought into place regulatory polices to give benefit to the borrowers to ease the financial crisis. The intention of the RBI is to maintain status quo as on March 1, 2020 with regard to all the instalments payment which had to be made post March 1, 2020 till May 31, 2020. Further, the relevant provision of the Regulatory Package with respect to classification of accounts also indicates that the intention of RBI is to maintain status quo with regard to the classification of accounts of the borrowers as they existed as on 01.03.2020. The relevant extract of the judgement is as follows:
- The restriction on change in classification as mentioned in the Regulatory Package shows that RBI has stipulated that the account which has been classified as SMA-2 cannot further be classified as a non-performing asset in case the instalment is not paid during the moratorium period i.e. between 01.03.2020 and 31.05.2020 and status quo qua the classification as SMA-2 shall have to be maintained.
This implies that for a period of three months there will be a moratorium from payment of the instalment. However, interest shall continue to accrue on the outstanding payment even during the moratorium period. Further, in case the borrower fails to pay the said instalment after the expiry of moratorium, the asset classification would change as per the IRAC Guidelines.
Bombay High Court Ruling
The Bombay HC has also taken a similar view on the issue of asset classification during moratorium. In the case of ICICI Bank against two real estate companies, namely Transcon Skycity Pvt. Ltd. and Transcon Iconica Pvt. Ltd., the HC has directed ICICI Bank to exclude the period of moratorium amid coronavirus lockdown while computing 90 days for declaration of non-performing assets.
As per the facts of the case, the petitioner companies had availed finance facilities from ICICI Bank, which were to be repaid in instalments, but they failed in repaying two instalments. As per RBI norms, for classification of accounts as NPA, the 90-days period would end during the current lockdown period. The plea of the petitioners was to restrain ICICI Bank from taking any coercive actions against them and sought the court’s declaration that they were entitled to benefits under the RBI’s relief packages permitting lending institutions to allow a three month moratorium on all loan repayments.
It was contented by the petitioners that if the moratorium period is not excluded from the NPA declaration period, the moratorium itself would be meaningless in situations such as those of petitioners. The HC also drew reference to the Delhi HC ruling discussed above, which concluded that the purpose of the moratorium and the entire rationale would be nullified if moratorium isn’t extended for accounts outstanding as on March 1, 2020.
The HC held that the moratorium period of March 1 till May 31, 2020 during which there is a lockdown will stand excluded from the NPA declaration computation until the lockdown is lifted. It further clarified that the relief is co-terminus with the lockdown period and not the declared end of the moratorium. The exclusion from the 90-day NPA-declaration timer and countdown can only therefore operate during the lockdown period and will end upon the complete lifting of the lockdown.
However, the concluding remarks of the order makes this a case specific decision. The HC cautioned that this order will not serve as a precedent for any other case in regard to any other borrower who is in default or any other bank and that each of these cases will have to be assessed on their own merits.
Another Ruling by Delhi HC
The Delhi HC has again addressed the issue of applicability of the moratorium period in the classification of an asset as an NPA. In the case of Shakuntala Educational & Welfare Society v Punjab & Sind Bank the petitioner was a charitable society engaged in the business of technical and higher education which had sought the benefit of the moratorium period for loans that were due on December 31, 2019, and were payable until March 31, 2020.
The petitioner has been diligently making repayments in accordance with the restructured plan of it remaining two terms loan but before the instalments payable in March, 2020, could be paid, the pandemic COVID had set in and consequently the RBI permitted grant of three month moratorium, vide its circular dated March 27, 2020, in respect of all term loans as outstanding on March 1, 2020. The petitioner was liable to make payment of quarterly instalments, and the default qua instalments in respect whereof the respondent is proposing to declare the petitioner’s accounts as NPA had fallen due on 31.12.2019. However, the petitioner expressed its inability to pay as several of its schools run in Uttar Pradesh (UP) were affected by the state government directive by which they could not insist on students making fee payments.
The HC considered the fact that the petitioner still had time to make the payment of the due instalments till March 31, 2020, before which date on account of the lockdown and directive issued by the State Government, it has been prevented from demanding the due fees from the students of its various institutes.
The HC concurred with the view taken in the ruling discussed above that the regulatory package intended to maintain status quo as on 1 March as far as classification of accounts is concerned. Accordingly, an interim relief was granted to petitioner by restraining the respondent bank from declaring the loans as an NPA until the next hearing. The Court, further, agreed to the proposal of the petitioner and added a caveat in this order stating that in case the directive of the UP government prohibiting fee collection is lifted before the next hearing, the petitioner would be liable to pay the pending dues within one week of such lifting.
Though the HC made reference and agreed to the view taken in the earlier ruling of Anant Raj Limited Vs. Yes Bank regarding maintaining status quo due to the moratorium period, however, the judgement was linked to a specific impact of the lockdown that is, the state government directive. In effect, it has delinked the asset degradation from both the lockdown and the moratorium period.
The first judgement of Delhi HC is in favor of extending the moratorium period to loans outstanding before March 1, 2020 by stating maintenance of status quo and justifying the same by a contextual reading of the RBI’s Regulatory Package, however, the orders in the other two cases are fact specific, one of which even reiterates that it cannot be treated as a precedent.
Deterioration to NPA status has manifold consequences, including provisioning requirement that have an impact of the P&L accounts. For NBFCs, their drawing power from banks comes down as NBFCs are not allowed to borrow against past due receivables. This will exacerbate the liquidity issue with NBFCs. Further, under the ECL provisions under IndAS 109, the continuation of default will cause the bucket of the receivables to move from Bucket 1 to Bucket 2, thereby requiring computation of lifetime expected losses. This may mean a huge impact on long-term receivables, as those in case of housing or project loans.
Post the HC judgement, two things have been clarified:
- An account already classified as NPA as on 29th Feb remains an NPA.
- An account that is not an NPA on 29th Feb and is just classified as SMA then the ageing of the receivable shall not change during the moratorium and any further asset degradation shall not happen.
Accordingly, the possible scenarios can be summarized as follows:
|Existing Asset Classification||Whether moratorium can be granted?||Whether asset classification shall remain stand still?|
As per the practice adopted by banks and NBFCs, including HFCs, it seems that most of them have extended the moratorium on all standard loans, irrespective of whether they were overdue as on 1st March, 2020. Further, post the HC ruling, the asset classification of account which has been classified as SMA cannot further be classified as a non-performing asset in case the instalment is not paid during the moratorium period and status quo qua the classification as SMA shall have to be maintained. However, there is a possibility that the ruling may be challenged in a higher court, and the outcome of that ruling could be completely different. Therefore, until this ruling is challenged further or any clarification contrary to this issued by the RBI or any other authority, financial institutions may consider this ruling to frame their policy for account classification.
This article is further being updated in accordance with the RBI Governor’s address on April 17, 2020 and a subsequent notification on the issue that has clarified the position once and for all. The RBI circular states that in respect of all accounts classified as standard as on February 29, 2020, even if overdue, the moratorium period, wherever granted, shall be excluded by the lender from the number of days past-due for the purpose of asset classification under the IRAC norms. Effectively the circular stalls the dip in the asset classification by 3 months. Further, the asset classification relaxation is provided only if the account was to move from standard to sub-standard category during the moratorium period from March 1, 2020 to May 31, 2020. However, if the account was within the NPA category already, the benefit of the relaxation will not be available.
 Our detailed FAQs on the subject can be viewed at http://vinodkothari.com/2020/03/moratorium-on-loans-due-to-covid-19-disruption/
 In terms of the IRAC Guidelines, if an instalment is overdue by a period of 30 days, the borrower’s account is classified as Special Mention Account 1 (SMA-1) and if the instalment is overdue by 60 days, the account is classified as Special Mention Account 2 (SMA-2) and if the instalment is overdue by a period of 90 days, the account is classified as Non-performing Asset (NPA).
 W.P.(C) URGENT 5/2020
 WRIT PETITION LD-VC NO. 28 OF 2020 and WRIT PETITION LD-VC NO. 30 OF 2020