Deteriorating asset quality in the banking system has prompted the Reserve Bank of India to publish a discussion paper “Early Recognition of Financial Distress, Prompt Steps for Resolution and Fair Recovery for Lenders: Framework for Revitalising Distressed Assets in the Economy”.

The paper has attempted to address both the proactive steps to prevent slippage in asset quality as well as reiterate some of the earlier guidelines that the regulator had issued.

Better Risk Management For starters, the regulator has reinforced the importance of credit risk management. Banks have been asked to carry out independent and objective credit appraisal in all cases and not depend on credit appraisal reports prepared by outside consultants. They have been mandated to ascertain the source and quality of equity capital brought in by the promoters.

This primarily ensures that multiple leverages, especially in infrastructure projects, are eliminated. Banks have been required to verify the source of the equity capital in the subsidiaries/SPV to ensure that debt of the parent company is not infused as equity. Banks are now additionally required to verify if the names of any of the directors of the company appear in the list of defaulters/wilful defaulters. They also have to classify borrowers as “non-cooperative borrowers” — those who do not provide necessary information to assess financial health even after two reminders or deny access to securities or do not comply with the terms of the sanction.

The RBI proposes to create a database of directors on the boards of companies, classified as non-cooperative borrowers, for dissemination to lenders. Banks have asked not to rely on certification given by borrower’s auditors.

The central bank has also brought the advocates and asset valuers within the radar. While blacklisting of professionals by banks has always been in vogue, it has to be viewed in the context of the provisions under Section 447 of the new Companies Act 2013, which envisages class-action for abetment to fraud.

The proposed guidelines also envisage a higher degree of monitoring in respect of advances already made. Banks have now been mandated to create a new sub asset category “Special Mention Accounts (SMA)”. The concept of SMA is not new in the context of the Indian banks.

The regulator, as early as September 2002, had issued guidelines on preventing slippage of NPA accounts. SMAs find reference even in that document. SMA has now been further sub-categorised into SMA-NF, SMA-1 and SMA-2.

A loan can be potentially categorised as SMA-NF, if any one of the following, illustrative signals, are noticed — delay of 90 days or more in the submission of stock statements or other operating control statements including non-renewal of facilities based on audited financials; actual sales/operating profits falling short of projections, for loan sanction, by 40 per cent or more; non-cooperation for conduct of stock audits or reduction of drawing power by 20 per cent or more after stock audit or evidence of diversion of funds; return of three or more cheques or electronic debit instructions in the last 30 days on account of non-availability of funds; return of three or more bills/cheques sent on collection by the borrower; devolvement of letters of credit or invocation of bank guarantees and its non-payment within 15 days; increase in frequency of overdrafts in current accounts and borrower himself reporting stress in business and financials.

SMA-1 represents a category where the principal or interest payment is overdue between 31 and 60 days, and SMA-2 where principal or interest payment is overdue between 61 and 90 days.

The existing guidelines provide for assets to be categorised as NPAs, where principal and/or interest are not paid for 90 days or more. The RBI proposes to set up a Central Repository of Information on Large Credits (CRILC) that will collect, store and disseminate credit data by the banks.

Additionally, important non-banking financial companies are also required to submit data. Banks will be required to submit credit information to CRILC on borrowers having aggregate fund-based and non-fund-based exposure of Rs 5 crore and above.

Banks will also have to furnish details of all current accounts of their customers with outstanding balances, both debit and credit, of Rs 1 crore and above.

Banks will be required to submit SMA status of the borrowers to CRILC. If an account is categorised as an SMA-2 at any time or SMA-1 for any two quarters or SMA-NF for three quarters in a year, then the bank would be required to initiate the corrective action plan. Corrective Action

The implementation of the action plan is also proposed to be monitored closely. Failure to turn around stressed assets would warrant initiation of other recovery mechanisms. The document envisages a positive reconstructive role for asset reconstruction companies/private equity funds. The proposals are in the right direction and the challenge lies in their implementation.

(The author is a chartered accountant.)

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