Draft for discussion Confidential

0

m

Discussion note on key actions and reforms for the banking sector required upon opening up of businesses post the COVID-19 crisis 14 April 2020

Draft for discussion Confidential

1

Contents

1 Introduction ..................................................................................... 2

2 Current regulatory and policy environment ....................................... 3

3 Immediate impact of COVID-19 and problem statement .................... 4

4 Objectives ........................................................................................ 6

5 Categorisation of companies ............................................................. 7

6 Resolution for Sustainable Businesses (category A) .........................12

7 Resolution for Potentially Sustainable Businesses (category B) ........13

8 Resolution for Unsustainable Businesses (category C) .....................14

9 Additional support by the Government of India ................................15

10 Structuring of banks ......................................................................16

11 Conclusive remarks .........................................................................17

12 Summary ................................................. .......................................18

13 Interim measures ..........................................................................20

14 Contact details ...............................................................................21

14 Acknowledgment ...........................................................................21

2

1. Introduction

1.1. The onset and rapid spread of the Novel Coronavirus Disease (“COVID-19”) is taking a toll on human lives as well as hindering businesses across the globe. This poses a high risk to the Indian economy (“Crisis”).

1.2. In less than two months, the footprint of the virus has expanded beyond China to more

than 200 countries. As healthcare systems across the world are not equipped to manage the surge in cases, many countries took steps such as social distancing (in the form of imposing lockdowns and quarantine throughout the country) to contain the spread of COVID-19.

1.3. In addition, globally the problem is magnified from an economic standpoint on account

of the convergence of other factors. These factors include the oil price war, which has led to a significant reduction in price beyond what would be attributable to a decrease in demand on account of COVID-19, due to oversupply. These factors together have further led to credit funding and market dislocations, including a fall in yields. Economists are concerned that the impact can be amplified across sectors due to knock-on and multiplier effects across businesses.

1.4. India is also under lockdown where businesses (except those engaged in essential goods

and services) have paused operations to minimise the impact and spread of COVID-19. There is significant concern that once the economy opens up and businesses return to normality, the disruption due to this Crisis could lead to a systemic failure of businesses and the banking system because of a steep decline in asset quality, and a string of covenant breaches and defaults.

1.5. The Reserve Bank of India (“RBI”) has advised lenders to offer a three-month

moratorium on term loans and deferment of interest payment for working capital facilities. On a macro level, it would be advisable to provide additional boost to the business environment in terms of additional liquidity, ensuring additional liquidity for businesses that need it the most, policy impetus for priority sectors, etc., to help businesses and economy normalise at the earliest. The stabilisation of businesses may involve spreading the impact of this shock over a longer time horizon.

1.6. The government’s revenues have shrunk due to the Crisis, but its expenditure has increased towards providing necessary healthcare and essential goods and services during lockdown. As a result, its ability to offer additional packages to industry is limited. Also, focused distribution of any economic package would be time consuming. Hence, it may not serve the purpose of timely intervention or be wasteful if misdirected due to lack of rigour in determining rightful recipients.

1.7. Here, we believe the banking sector could step in to provide the desired and focused relief required. Therefore, it provides necessary support to businesses.

1.8. If proactive action is not taken at this stage, the impending recession would cut much

deeper and possibly last longer.

3

2. Current regulatory and policy environment

2.1. The RBI is the governing body that regulates commercial banking and non-banking

financial companies in India. The following key RBI regulations are critical for our subsequent discussions and reproduced below for reference:

2.1.1. Master Circular – Prudential Norms on Income Recognition, Asset Classification, and

Provisioning Pertaining to Advances dated 1 July 2015 (as amended)1: This circular provides for the norms to be followed for income recognition, asset classification, and provisioning.

2.1.2. Prudential Framework for Resolution of Stressed Assets dated 7 June 20192 (“RBI

Resolution Framework”): This framework provides for early recognition, reporting, and time-bound resolution of stressed assets. It allows complete discretion to lenders with regards to design and implementation of resolution plans, subject to the specified timeline and independent credit evaluation. The framework stipulates a system of disincentives in the form of additional provisioning for a delay in implementation of resolution plan or initiation of insolvency proceedings. The lenders are required to enter into an inter-creditor agreement to provide for ground rules for finalisation and implementation of the resolution plan in respect of borrowers with credit facilities from more than one lender. Any decision, per the terms of the ICA, with 75 percent voting share by value and 60 percent voting share by number would be binding on lenders. For implementation of resolution plans, other requirements are prescribed that include credit ratings, additional provisioning in case of dissenting lenders, and satisfactory performance for upgrading.

2.1.3. Master Direction - External Commercial Borrowings, Trade Credits, and Structured

Obligations dated 26 March 2019 (updated as on 8 August 2019)3: The provisions relating to External Commercial Borrowings (ECBs) are governed by the Foreign Exchange Management (borrowing and lending) Regulations, 2018, new ECB framework dated 16 January 2018 and master directions on ECBs, trade credits, and structured obligations dated 26 March 2019 (collectively referred to as “ECB Regulations”) under Foreign Exchange Management Act 1999 (FEMA).

2.2. Insolvency and Bankruptcy Code4: The Insolvency and Bankruptcy Code, 2016 (“IBC”)

is a crucial legislation, and consolidates and amends the laws relating to reorganisation and insolvency resolution of corporate persons, partnership firms, and individuals in a time-bound manner for maximisation of value of assets of such persons, to promote entrepreneurship, ensure availability of credit, and balance stakeholders’ interests. IBC provides an effective platform for resolution of companies in default of their financial obligations. Sometimes, the code provides a deterrence that promotes resolution of the stressed accounts under the RBI Resolution Framework.

1 https://www.rbi.org.in/Scripts/BS_ViewMasCirculardetails.aspx?id=9908

2 https://www.rbi.org.in/Scripts/NotificationUser.aspx?Id=11580&Mode=0 3 https://m.rbi.org.in/Scripts/BS_ViewMasDirections.aspx?id=11510 4 https://ibbi.gov.in//webadmin/pdf/legalframwork/2017/Jul/IBC%202016.pdf

4

3. Immediate impact of COVID-19 and problem statement

3.1. Primary Impact - Businesses would go through an extended but a finite period with

reduced revenues and continuing fixed costs. During this Primary Impact Period, business activities across various sectors shall be severely affected. At the same time, some businesses may be seen to be resilient, and some may have even done better. However, there is large concern that a majority of businesses would look at large costs/losses, resulting in a weaker balance sheet.

3.2. Primary Impact Period: This is anticipated to continue for a finite time period (may be

two quarters), after which businesses would start returning to normality. 3.3. Normalisation: After the Primary Impact Period, businesses will resume normality

through a recovery curve, which could be (a) a rapid V-shaped curve, or (b) a gradual U-shaped curve, or (c) in the worst case scenario in an L-shaped curve.

3.4. Liquidity crunch: The abnormal losses caused by the Crisis, including a halt in trading,

could lead to pressure on cash position and working capital. Some businesses may not have enough liquidity to meet operating expenses, debt servicing, etc. They may struggle once situation normalises and require additional working capital to restart or normalise operations.

3.5. Potential rating downgrade: Due to impaired operations during this period, the abnormal losses could lead to a breach of ratios and business metrics, which were agreed in lending covenants. This poses an additional risk of increased pressure on cash flows. A downgrade of the rating can lead to additional costs of capital on incremental debt from existing lenders (due to a lower rating) and a liquidity challenge as new banks/lenders would be averse to lending to businesses with rating below certain thresholds. It could also lead to additional pressure on companies that have borrowed money from the domestic and offshore markets (from insurance companies, mutual funds, and offshore debt/impact investors) in the form of NCDs, ECBs, PTCs, and via direct assignments. These instruments are currently not under the RBI moratorium. A rating downgrade of one instrument could potentially trigger accelerated redemptions on other instruments of the borrower.

3.6. Domino effect: Reduction in rating can lead to additional costs of capital and trigger an

event of default. This can allow lenders to recall their funds and hence, further increase the stress on businesses. When the businesses starve for liquidity, they will be unable to borrow to resume their normal operations because of their revised lower ratings. This in turn will cause businesses, which are long-term Sustainable Businesses to also default in the short term.

3.7. Effect on banking sector: Large-scale business defaults would result in burgeoning

non-performing assets, leading to massive provisioning requirement, and adversely affecting banking liquidity and operations. It could in turn cause potential failure of the banking system.

5

3.8. Need for intervention: The government and the RBI should consider to intervene to ensure that businesses do not collapse en masse and in turn, push banks into a systemic lockdown/failure due to points 3.1 to 3.7 mentioned above (the “Crisis Trap”).

3.9. Resolution: The government, the RBI, and banks should consider to collectively focus

on Sustainable Businesses and pull them out of the Crisis Trap. Even if such businesses may be more limited in number and larger, the impact of their survival would be far reaching. Their survival will affect their vendors in their supply chains, customers in the chain downstream, and the related ecosystems.

6

4. Objectives 4.1. This note discusses whether it is possible to isolate the effect of this Crisis on businesses

and define actions. Such actions, if taken, can restrict or mitigate the impact on sustainable businesses and simplify the restructuring process for other businesses to ensure that we do not end up in a situation of a systemic lockdown of the banking system.

4.2. This would include allowing the sustainable businesses, if required, to obtain additional

financing. 4.3. This note also discusses various innovative solutions that the government, the Ministry

of Finance, the RBI, and lenders could consider.

7

5. Categorisation of companies 5.1. It is critical to look at banks’ asset portfolios and classify accounts in broad buckets,

after the Crisis, so that a targeted approach may be taken as follows: 5.1.1. Category A – Businesses that would be healthy, after excluding the impact of the

Crisis, and project forward as sustainable with support, in the form of additional liquidity and some augmenting of the balance sheet, would qualify as Sustainable Businesses. Simply put, such businesses whose rating, after adjusting for the “COVID Crisis Investment” (defined as excess of operating costs, including non-cash and finance costs, over revenues during the Primary Impact Period) made by it and the potential Crisis Liquidity Bridge assumed to have been disbursed by banks, being lower by not more than [2] notches of their last rating and more than [RP4] would also be defined as long-term sustainable businesses (“Sustainable Businesses”). The government may issue a clarification to the existing accounting standards and the provisions of the Companies Act, 2013 to allow recognition of the COVID Crisis Investments in companies’ books. This would enable compliances, and provide a guidance for statutory and internal audit purposes.

5.1.2. Category B – Businesses that have the potential to be healthy but require support

beyond additional liquidity and augmentation of the balance sheet, in the form of restructuring of their existing liabilities, would fall in this category. In such cases, after suitable restructuring, a company’s rating, after proposed restructuring and adjusting for the COVID Crisis Investment made by it and the potential Crisis Liquidity Bridge assumed to have been disbursed by the banks, being lower by not more than [2] notches of the last rating and more than [RP4] would also be defined as long-term potentially sustainable businesses (“Potentially Sustainable Businesses”). For these businesses, a resolution through restructuring is likely to be possible with or without current management.

5.1.3. In cases of Sustainable Businesses and Potentially Sustainable Businesses, initiation of insolvency or security enforcement may possibly lead to further deterioration of value and not result in a meaningful realisation for lenders. Therefore, insolvency or security enforcement is not considered an optimal solution.

5.1.3.1. These businesses are likely to benefit from additional liquidity based on feasibility

studies, a high level of monitoring, possible deep restructuring in cases of EBITDA potential, etc.

5.1.4. Category C – Businesses that after Crisis are unsustainable or where the promoter’s

integrity/capability is considered doubtful (“Unsustainable Businesses”) would fall in this category.

5.1.4.1. For this category, banks may consider preserving or nurturing assets until the market

stablises. After that, they can seek to monetise, or where required, take immediate action in terms of IBC, enforcement of security, etc.

5.2. In the past, banks typically found it hard to classify accounts as that involved a

significant level of judgement and responsibility. A simple and systematic approach has been proposed to enable the categorisation for this purpose. Further,

8

categorisation based on these pre-defined criterions should not be subject to scrutiny in the future, enabling its efficient implementation.

5.3. Limited review of information provided by the company will be undertaken by its

statutory auditor within a fixed timeframe of preferably about 3 days to quantify the COVID Crisis Investment quantum for the company. Banks could then, with the assistance of suitable external agencies, if required, carry out an internal rating exercise to evaluate whether a maximum Crisis Liquidity Bridge of up to the COVID Crisis Investment amount would help the company run as (a) a Sustainable Business or (b) a Potentially Sustainable Business or (c) would not be able to prevent it from being unsustainable. Such a rating for classification would be undertaken within 7 days of the receipt of such application for a Crisis Liquidity Bridge by the company.

5.4. Such application shall be made by the company to the lead bank of the consortium or

the largest lender to the company, as the case may be (the "Processing Bank"). 5.5. The Processing Bank shall form a committee, which shall be the single window, for

clearance of such Crisis Liquidity Bridge and review of the credit for the bridge. If approved, the amount of the Crisis Liquidity Bridge shall be disbursed pro rata by Indian banks, NBFCs, and financial institutions to their current lending as a share of total lending by Indian banks, NBFCs, and institutions to the company, unless the Processing Bank decides to disburse the entire amount itself.

5.6. The Processing Bank and other Indian banks, NBFCs, and institutions shall disburse

the Crisis Liquidity Bridge amount within 3 working days from its approval by the Processing Bank.

5.7. Further, the companies may be required to submit quarterly or half-yearly audited

accounts to revalidate the COVID Crisis Investment. 5.8. The proposed support should be implemented through a “two-step process”. 5.9. Step 1: Balance sheet correction 5.9.1. To implement this, the following actions should be considered: 5.9.1.1. The RBI should suspend fresh ratings for a period of three quarters from date of

publication of notification, making effective tenets of this proposal. Covenant testing should be deferred or may be relaxed suitably based on the current situation of businesses.

5.9.1.2. A specific COVID dispensation by way of an amendment to the accounting standards

or releasing of a new accounting treatment by Ministry of Corporate Affairs (MCA) or Institute of Chartered Accountants of India (ICAI), in connection with the existing accounting standards, and corresponding amendment in the Companies Act, 2013 may be introduced. It should allow for capitalisation of COVID Crisis Investment and their subsequent amortisation over a period of [5] years, and their treatment as special deferred expenditure as part of long-term sources until they are fully amortised. The impact on account of COVID Crisis Investment is being moved from profit and loss (P&L) account to the balance sheet, where it would have earlier reduced reserves and surplus, but would appear as COVID Crisis Investment in lieu of cash/liquidity erosion on the asset side. For funding of such cash/liquidity erosion, Crisis Liquidity Bridge support is proposed to be provided by banks.

9

5.9.1.3. This would avoid such costs to be directly reflected in their P&L, and amortised over a period of say 5 years. This capitalisation and subsequent amortisation over a period would gradually help bring the financial ratios and business metrics back to normal. It seeks to isolate the effect of the Crisis and reduce a potential cascading effect.

5.9.1.4. The RBI and banks should come with a policy (or a special dispensation) to note this

amendment and require consideration of revised profitability situation after making such adjustments. Earlier, lenders often sought to add back adjustments relating to intangibles. Hence, the RBI could offer a special dispensation to banks to restrict the adding back of the amortised amounts while testing for lending covenants or even for new financial analysis.

5.9.1.5. Testing for lending covenants or financial analysis for the purpose of ratings, etc.,

should also be for a period excluding Primary Impact Period during the financial year for a normalised analysis. For the purpose, audited financial statements may report accounts after capitalising the COVID Crisis Investment, hence limiting its impact on the company’s P&L account.

5.9.1.6. This adjustment should also be applicable for listed bonds that SEBI governs. SEBI

should also recognise and allow the amortisation. 5.9.1.7. The RBI and SEBI can also consider making this adjustment applicable for rating

agencies during their evaluations. 5.9.1.8. Banks should proceed with Crisis Liquidity Bridge disbursement on the basis of the

internal ratings process to be undertaken by them as envisaged above. This could be revalidated by subsequent ratings carried out within two quarters of such disbursement by a third-party rating agency.

5.9.1.9. Banks should continue classifying the accounts in line with currently applicable

guidelines (standard, SMA1, SMA2, etc.). Only an adjustment on account of COVID Crisis Investment and Crisis Liquidity Bridge will be carried out to continue with the current classification (standard, SMA1, SMA2, etc.).

5.9.1.10. The suggested categories are not a new classification system but guidelines for

disbursement of the Liquidity Crisis Bridge in line with the COVID Crisis Investment made by a company. The system remains unaltered but will be applied after adjustment for both the Crisis Investment and the Crisis Liquidity Bridge (to determine whether the Crisis Liquidity Bridge is actually to be disbursed).

5.10. Step 2: Liquidity correction 5.10.1. For businesses that can continue to be viable on the basis of above analysis and

balance sheet augmentation, additional funding could be provided to restore businesses and for working capital.

5.10.2. The RBI needs to direct banks to consider a Crisis Liquidity Bridge, which matches the

COVID Crisis Investment by the Company after the single window clearance process for categories A and B.

5.10.3. Businesses that require additional funding in order to remain viable, and those that

are not meeting the criteria for categories A and B, could be considered for corrective actions on a case-by-case basis, by banks.

10

5.11. Government’s role 5.11.1. The government may consider to provide limited support in the form of: 5.11.1.1. Guarantee/support to the debt raised by banks to provide the Crisis Liquidity Bridge

to various qualifying companies. 5.11.1.2. Guarantee to lending banks for the Crisis Liquidity Bridge, provided by them to each

qualifying company, for benefit of the bank against any loss/default on account of Crisis Liquidity Bridge. This will collateralise the loan extended and eliminate the need for any additional security creation against the company’s assets or by means of personal guarantees of promoters for the express disbursement of the Crisis Liquidity Bridge, and there wouldn’t be any impact on bank’s balance sheet in form of additional provisioning on account of Crisis Liquidity Bridge.

5.11.1.3. Amend The Fiscal Responsibility and Budget Management Act, 20035 and general

financial rules to facilitate provision of aforementioned guarantee beyond annual limits and relaxation in associated conditions as may be required.

5.11.1.4. Potential monetisation of dues from governments can further aid liquidity. A short-

term solution to secure additional funding by banks could be issuance of certificates of dues (such as an IOU) by the government, with specific provision made for recognising such certification as due security. Such a certificate carrying enabling language that allows for it to be mortgaged to institutions that lend against it, to ensure that the certificate may be cashable by those lending against it. This can be useful for monetisation of refunds, taxes, etc.

5.12. RBI’s role 5.12.1. The RBI may consider to provide limited support in the form of: 5.12.1.1. Allow creation of a special account by banks to deal with the Crisis Liquidity Bridge to

various qualifying companies’ requirements. 5.12.1.2. Interim liquidity to banks through reduced CRR to fund the Crisis Liquidity Bridge for

various qualifying companies. 5.12.1.3. Issuing debt by banks to the RBI/public at large to be allowed to raise funds

equivalent to the Crisis Liquidity Bridge provided to various qualifying companies by banks, and return the additional liquidity they had used during the CRR relaxation.

5.12.1.4. The RBI should suspend fresh ratings for a period of three quarters from the date of

publication of a notification, making effective tenets of this proposal. 5.12.1.5. Directing rating agencies to adjust for COVID Crisis Investment and Crisis Liquidity

Bridge to monitor current and assess future ratings. 5.12.1.6. Issue requisite guidelines for banks to consider the following:

5 https://dea.gov.in/sites/default/files/FRBM%20Act%202003%20and%20FRBM%20Rules%202004.pdf

11

5.12.1.6.1. Revised profitability situation of businesses after making requisite adjustments on account of COVID Crisis Investment

5.12.1.6.2. A Crisis Liquidity Bridge that matches the COVID Crisis Investment by the company

for sustainable businesses 5.12.1.7. A special treatment of the bonds to be allowed in banks’ balance sheets for Crisis

Liquidity Bridge support to be extended through a special account created in every bank.

12

6. Resolution for Sustainable Businesses (category A)

6.1. Banks/NBFCs/financial institutions to disburse Crisis Liquidity Bridge to category A

businesses within timelines, upon approval of such funding by its single window clearance committee of the Processing Bank.

6.2. Support from businesses 6.2.1. For additional control and monitoring, lenders should be permitted to: 6.2.2. Appoint a CFO/CRO or independent directors who shall represent lenders interests. The

CFO/CRO should have certain powers to block the business decisions, which may be detrimental to the interest of the lenders.

6.2.3. Appoint agencies to monitor business operations and cash flows.

13

7. Resolution for Potentially Sustainable Businesses (category B)

7.1. Amendment to the Prudential Framework for the Resolution of Stressed Assets 7.1.1. The RBI may notify guidelines to consider the current 7 June 2019 circular’s

recommendations in conjunction with impact of the potential Crisis Liquidity Bridge, which matches the COVID Crisis Investment by the company.

7.1.2. In addition, the RBI may come up with a new framework for assets affected by the Crisis

and permit resolutions as proposed in the subsequent parts of this note. 7.2. Support from businesses 7.2.1. Additional control and monitoring: 7.2.2. Control provisions should be similar to the powers provided under the IBC, i.e., lenders

should be able to appoint someone CFO/CRO/director who shall report to lenders and have control on the company’s cash flows. The CFO/CRO/director should also have a veto power to prevent the promoter’s decisions (such as giving loans to group companies, additional investments, and expansions), which may be detrimental to lenders’ interest. This CFO/CRO/director should be a professional and responsible to the bank, along with the company’s board and shareholders.

7.2.3. There should also be operational and cash flow controls, which require authorisations from lenders’ representatives.

7.2.4. Deviations from the control or operating protocol would lead to lenders initiating

insolvency.

14

8. Resolution for Unsustainable Businesses (category C)

8.1. In this category, businesses are not sustainable or the viability is uncertain, or the long-

term viability cannot be established; for example, power projects that are incomplete and require significant capital infusion to make the business operational.

8.2. These could also include cases where lenders do not have comfort from promoters; for

example, issues such as diversion of funds or the promoter’s doubtful integrity, are identified from forensic reviews.

8.3. Four options are available for lenders.

8.3.1. Hold and work out: In some cases, given the current market situation, finding a buyer

can be challenging. It may be a better option to nurture the asset and sell at the right time (not longer than [2] years later). Banks can look to appoint professional management and even provide some funding or working capital to the extent there is a commercial rationale and is required for value maximisation.

8.3.2. Sale: In cases where banks believe that sale of the assets including at a deep discount is the best option, they should be permitted to sell and account for any loss over a period of two-three to avoid a sudden impact on banks’ books. One of the pre-conditions to the sale should be a proper price discovery process. Currently applicable guidelines relating to sale of assets/ loans shall continue to apply, except for proposed amortization of losses over an extended period.

8.3.3. Insolvency: Additionally, where banks believe that there is no good option in the foreseeable future or they believe that the case is complex and an insolvency process could be the best option, banks should refer the matter to IBC. This would be subject to moratorium, if any, imposed by the Government on initiation of insolvency process in light of Crisis.

8.3.4. Prepack provisions: The government is working on setting up a process for pre-pack insolvencies, i.e., cases where the resolution is agreed before declaring a company insolvent. This should be introduced immediately and can be used as a method of parking assets into the bad bank.

8.4. Support from businesses 8.4.1. Additional control and monitoring 8.4.1.1. For these cases, high level of management is needed by banks. The bank representation

should have complete operational and financial control on the business.

15

9. Additional support by the Government of India (GoI)

9.1. The proposed solution also provides substantial benefit to the government: 9.1.1. The proposed solution avoids a direct budgetary support by the government to

businesses. 9.1.2. Instead of immediate cash outflow to support businesses in the form of refunds of tax

and other dues, by issuing certificates of dues that can be mortgaged to raise funds, the government is able to preserve its own liquidity for now.

9.1.3. The proposed solution ensures that additional liquidity flows to businesses that need it

the most and avoids its potential waste due to lack of rigour in determining rightful recipients.

9.1.4. This enables viable businesses to return to normalcy faster once the economy opens

up, preserve employment, growth of economy, etc. This helps prevent failure of the banking system.

9.2. The government could come up with industry/sector specific concessions to support the

economy. These concessions may include an additional corpus of funds to be routed through SIDBI for equity contribution for restructuring proposals.

9.3. The government may also allow entire COVID Crisis Investment as a tax-deductible

expense during the relevant financial year of the Primary Impact Period. 9.4. Income of banks/NBFCs/FIs from Crisis Liquidity Bridge may be exempted from tax or

taxed at a substantially lower rate for the next [2] years. 9.5. The option of the three-month moratorium (permitted by the RBI on account of COVID-

19) may result in cross defaults under certain lending covenants if either (1) offshore bond issuers look at the moratorium as a potential restructuring of the loan or (2) there is a breach of the ratings threshold stated in their agreement. In addition, companies would be under redemption pressure for market borrowings currently not covered under the moratorium. Therefore, Sustainable Businesses may not opt for this option and struggle for a longer period to return to normalcy. The government may consider advising banks to give additional loans to the extent of principal and interest loan repayment between April 2020 and September 2020.

16

10. Structuring of banks 10.1. In the preceding sections of this note, we have proposed that lenders provide additional

funding and liquidity to businesses, which have the potential to be viable. 10.2. Given the magnitude of the Crisis where many businesses may fall under categories B

and C, these shall require specialised efforts from a resolution and recovery perspective. Additionally, even the category A businesses may require additional support from lenders.

10.3. To allow banks to concentrate on their core business of lending, the categories B and C

account can be carved out into another vehicle, which can issue paper to banks and should allow amortisation of period.

10.4. From a structuring perspective, a separate accounting or vehicle where the stressed

accounts could be parked, is similar to the good bank and bad bank concept considered in earlier cases of large bank restructurings of Citigroup, Royal Bank of Scotland, etc.

10.5. According to the concept, the assets that are dragging a business down or appear as

having a differential risk profile could be parked in a separate entity. Lenders will need to identify the holdings that are worth less than their earlier estimates, and should park them separately with a separate capital structure.

10.6. Unlike asset restructuring companies where sometimes incentives are misaligned due

to management fees, SRs, in case of the bad bank, there should be a higher incentive to turnaround and recover by appointing professional management for monitoring accounts from an operational perspective. The bad bank can first seek to work out or nurture businesses until there is a stable market to sell them.

10.7. The creation of a ‘bad bank’ can insulate the healthy part of the banking institutions. 10.8. The bad bank should also be allowed to house ownership of asset for which no

adequate value was received under an IBC or Swiss challenge process. 10.9. The accounts managed by the bad bank should have viability studies carried out and be

extensively monitored.

17

11. Conclusive remarks 11.1. There has to be a concentrated and proactive effort by the RBI, the Ministry of Finance

(including the Department of Revenue), SEBI, and banks, MCA, and ICAI to institute a mechanism to check that healthy businesses should recover for a larger protection of economy.

11.2. The RBI’s policies and guidelines for Income Recognition and Asset Classification

continue to remain applicable without any amendment. The RBI Resolution Framework dated June 7, 2019 may be considered in conjunction with adjustment on account of COVID Crisis Investment and impact of Crisis Liquidity Bridge.

11.3. Professional management should be of the highest level and the best practices should

be followed across accounts where banks are involved, with an objective to enable restructuring and revive the economy.

11.4. Swift support is required to help businesses revive their operations and minimise the

impact of the Crisis. At the same time, the banking sector should initiate radical changes, under enabling amendments by the RBI and finance ministry.

11.5. Ensuring the availability of adequate funding is essential to ensure that businesses do

not trip unnecessarily. With the help of professional management and monitoring, turnarounds should be encouraged.

18

12. Summary 12.1. Requirements/Support from the RBI

12.1.1. Suspend ratings for a period of three quarters. 12.1.2. Direct rating agencies to adjust for COVID Crisis Investment to monitor current and

assess future ratings. 12.1.3. Issue requisite guidelines for banks to consider the following: 12.1.3.1. Evaluate revised profitability situation of businesses after making requisite adjustments

on account of COVID Crisis Investment 12.1.3.2. Evaluate disbursal of Crisis Liquidity Bridge, which matches the COVID Crisis

Investment by the company for Sustainable Businesses 12.1.3.3. Evaluate disbursal of Crisis Liquidity Bridge, which matches the COVID Crisis

Investment by the company for Potentially Sustainable Businesses after restructuring 12.1.3.4. Categorise businesses in line with proposed predetermined criterion, to avoid any

scrutiny in the future, and proceed with applicable resolution – decision on additional funding and subsequent disbursal by Indian consortium lenders (banks, NBFCs, and FIs) of funding to businesses within a stipulated timeframe.

12.1.4. Consider providing concessional funding or a reduced CRR for a longer period of time to

facilitate additional liquidity with banks. 12.1.5. Allow a special treatment of these bonds in banks’ balance sheets for Crisis Liquidity

Bridge support to be extended through a special account created in every bank. 12.1.6. Provide a special window to banks to seek refinance against these specific assets. 12.1.7. Introduce amendment to the Prudential Framework for the Resolution of Stressed

Assets. 12.1.7.1. The RBI may notify guidelines to consider the current 7 June 2019 circular’s

recommendations, in conjunction with impact of the Potential Crisis Liquidity Bridge, which matches the COVID Crisis Investment by the company.

12.1.8. Facilitate structuring of banks. 12.2. Requirements/Support from SEBI 12.2.1. Allow COVID Crisis Investment adjustment applicable for listed bonds, and recognise

and allow its amortisation.

19

12.3. Requirements/Support from MCA 12.3.1. Amendment to the accounting standards or releasing of a new accounting treatment by

MCA or ICAI in connection with the existing accounting standards, and corresponding amendment in the Companies Act, 2013, to allow the following:

12.3.1.1. Capitalisation of COVID Crisis Investment and their subsequent amortisation over [5]

year period 12.3.1.2. Treatment of COVID Crisis Investment as special deferred expenditure as part of long-

term sources until they are fully amortised 12.3.2. Facilitating limited review of company information by statutory auditors to quantify the

COVID Crisis Investment quantum for the company within a period of [3] days 12.3.3. Quarterly or half-yearly audit of businesses to facilitate revalidation of COVID Crisis

Investment quantum by banks 12.4. Requirements/Support from the government (including the Department of

Revenue) 12.4.1. Provide sovereign guarantee for bonds issued by banks to raise funds for this lending. 12.4.2. Provide guarantee to lending banks for the Crisis Liquidity Bridge, provided by them to

each qualifying company, for benefit of the bank against any loss/default on account of Crisis Liquidity Bridge.

12.4.3. Issue certificates of dues (such as an IOU) owed by the government, with specific

provision made for recognising such a certification as due security. Such a certificate carrying enabling language that allows for it to be mortgaged to institutions that lend against it. This ensures that the certificate may be cashable by those lending against it, and can be useful for monetisation of refunds, taxes, etc.

12.4.4. Industry/sector specific concessions, including additional corpus of funds, to support

the economy should be routed through SIDBI for equity contribution for restructuring proposals.

12.4.5. The government may also allow entire COVID Crisis Investment as a tax-deductible

expense during the relevant financial year of the Primary Impact Period to provide additional relief to businesses.

12.4.6. The government may consider advising banks to give additional loans to the extent of

principal and interest loan repayment between April 2020 and September 2020.

20

13. Interim measures 13.1. The RBI should suspend fresh ratings for a period of three quarters to prevent

downgrade in ratings on account of the COVID-19 Crisis. 13.2. The government may consider advising banks to give additional loans to the extent of

principal and interest loan repayment between April 2020 and September 2020. 13.3. The RBI should consider providing concessional funding or a reduced CRR for a longer

period of time to provide additional liquidity to banks. 13.4. The government should allow banks raise funds from bonds, such as tax-free bonds,

with special permissions and provide sovereign guarantee if required. 13.5. The government should issue certificates of dues (such as an IOU). It should also allow

these certificates to be mortgaged, as an interim mean of monetisation of refunds, taxes, receivable from the government, etc.

13.6. MCA/ICAI should advise statutory auditor to undertake the company’s limited review of

information and quantify the COVID Crisis Investment quantum. The RBI may also advise banks to evaluate companies’ viability after suitable adjustment of COVID Crisis Investment, and not take any coercive actions (such as invoking IBC and security enforcement) against Sustainable/Potentially Sustainable Businesses until further directions.

21

Deloitte refers to one or more of Deloitte Touche Tohmatsu Limited, a UK private company limited by guarantee (“DTTL”), its network of member firms, and their related entities. DTTL and each of its member firms are legally separate and independent entities. DTTL (also referred to as “Deloitte Global”) does not provide services to clients. Please see www.deloitte.com/about for a more detailed description of DTTL and its member firms. This material is prepared by Deloitte Touche Tohmatsu India LLP (DTTILLP). This material (including any information contained in it) is intended to provide general information on a particular subject(s) and is not an exhaustive treatment of such subject(s) or a substitute to obtaining professional services or advice. This material may contain information sourced from publicly available information or other third party sources. DTTILLP does not independently verify any such sources and is not responsible for any loss whatsoever caused due to reliance placed on information sourced from such sources. None of DTTILLP, Deloitte Touche Tohmatsu Limited, its member firms, or their related entities (collectively, the “Deloitte Network”) is, by means of this material, rendering any kind of investment, legal or other professional advice or services. You should seek specific advice of the relevant professional(s) for these kind of services. This material or information is not intended to be relied upon as the sole basis for any decision which may affect you or your business. Before making any decision or taking any action that might affect your personal finances or business, you should consult a qualified professional adviser. No entity in the Deloitte Network shall be responsible for any loss whatsoever sustained by any person or entity by reason of access to, use of or reliance on, this material. By using this material or any information contained in it, the user accepts this entire notice and terms of use. Reproduction and redistribution without prior permission is prohibited ©2020 Deloitte Touche Tohmatsu India LLP. Member of Deloitte Touche Tohmatsu Limited

14. Contact details Sumit Khanna Partner, Financial Advisory – Corporate Finance & Restructuring Services Email: sumitkhanna@deloitte.com Kaustubh Mittal Director, Financial Advisory – Corporate Finance Email: kmittal@deloitte.com

15. Acknowledgment Uday Bhansali Vijay Iyer

Rajesh R Agarwal Shrenik Baid

Shailesh Verma Amrish Shah

Abhijit Guhathakurta Rajeev Suneja

Rajiv Chandak Nirav Pujara

Ashish Ahuja