S No

The usual terms of an approved CDR package

Their implications

1

Book Debts of longer period –

Usually, book debts older than 90 days are not considered for arriving at the Drawing Power. However, where the Debtor is a Government Department/Agency or a PSU, their dues that are up to 180 days old will be taken into account for calculating the D.P.  But under a CDR package, this condition is further relaxed so as to include all trade debtors which are old up to 270 days in case of dues from a government department/agency or a PSU and  up to 180 days in case of all other Debtors.

By extending the age of the acceptable Debtors, the lending banks take a calculated risk because –

(a)  A Trade Debtor arises only after the sale of the finished product.  In case of a Service/Processing Unit, only after a particular transaction or a batch of transactions is completed, the applicable fee/income falls due.  Therefore, as compared to stocks, debtors are more liquid and less risky.  Debtors are preferable also because a third party (buyer) comes into the picture.  It is quite unlikely that both the borrower (vendor) and the third party (buyer) default together, at the same time.

(b)  On the other hand, by extending the age of the debtors, the realization period gets extended and the operating cycle becomes greater.  The borrower may become slack in recovery of debtors that may ultimately lead to his inefficiency in operations.

2

Reduction of margin on various funded facilities

Reduction of margin results in lower stake of the borrower.  In each loan transaction of the bank, the extent of the lender’s commitment will go up and the borrower’s share will come down.  This may lead to lesser interest and motivation of the borrower to continue his activity with the required briskness and care.

3

Waiver of margin on non-funded facilities

Since the borrower’s stake is not there any loan transaction of the bank, the borrower may show a lackadaisical attitude and may not be prudent enough to conduct his business on healthy lines.  Banks must be extra-vigilant when demand for total waiver of margin comes from the borrower.  As compared to waiver, reduction in margin is recommended.

4

Extension of the Gestation/Moratorium period

While this may help the deserving borrower to concentrate better on his day to day operations during the ‘start up’ period, it postpones the recovery of the bank dues.  So, the cash inflows of the bank get affected.

5

Rescheduling of the existing Term Loans

Rescheduling is done by extending the repayment period, thereby reducing the instalment amount.  The borrower can service his interest obligations more efficiently, because of reduced commitments on payment of term loan instalments.  While this may improve the ‘Debt Service Coverage Ratio’, the ‘Interest Service Coverage Ratio’ is adversely affected.    From the ‘Asset Liability Management’ point of view, the lending bank has to redraw its further lending plans because of reduced cash inflows.

6

Conversion of the unpaid interest on working capital facilities into short term loans, in the form of ‘Funded Interest Term Loans’ (FITL)

This helps the borrower to postpone his outstanding interest liability and he will be freed from the burden of paying the interest dues in one stroke.  But, for the lending banker, his income is directly impacted.  The bank’s profitability will be affected owing to non-recovery of interest due, coupled with the need for making necessary provisions in view of the deterioration in the quality of the asset.  Another important point is, this kind of accommodating a defaulting borrower sets a bad precedent and it will encourage many more delinquent borrowers to demand conversion of unpaid interest into short term loans.

7

Waiver of interest from a particular date in the past

This is one of the major sacrifices made by a lending bank in the CDR exercise.   Often, it is misused by the borrowers who have diverted bank’s money for other purposes.  Banks do not ordinarily agree to this kind of demand from a borrower.  But, due to some other considerations that cannot not be made public, interest waiver for a particular period is accepted by the lending bank.

8

Reduction of Rate of Interest – either prospectively or restrospectively

Reduction of interest is often the result of hard bargaining by a borrower who attempts to bring influence from all possible sources.  Reduction of interest is therefore not done on any scientific lines, as it shall be.

9

Conversion of compound interest into simple interest

This lessens the interest burden of the borrower.  While it will really be helpful in case of past interest due, in case of future interest, there is hardly any difference between simple interest and compound interest, especially when the interest needs to be paid, as and when debited, unless otherwise stated in the CDR package.

10

Sanction of additional finance in the form of Working Capital Term Loans (WCTL)

This infuses greater liquidity for the short term needs of the borrower – to finance current assets and to pay off current liability.   Here, the borrower is made to bring in additional margin upfront, ranging from 15% to 25%.  RBI is seriously contemplating to fix the minimum upfront margin of the borrower at 25%.

11

Release of securities upon payment of a loan

This is a very dangerous proposal.  Banks shall not agree to the request of the borrower to release the most critical and important asset of very high value mortgaged to them.  It is a common knowledge that in case of multiple facilities, all securities are all pooled together and charged to the bank covering all the liabilities of the borrower, instead of taking various assets facility-wise.  The underlying rationale is the overall asset coverage ratio shall remain intact, adequate and easy to calculate.

11

Release of securities upon payment of a loan (continued)

I wish to narrate two instances of blunder committed by Bank ‘A’ and Bank ‘B’ in this connection.

Bank ‘A’ had extended many facilities to one of its borrowers and among them was a Housing Loan of Rs.3.00 Crores granted for construction of a residential house costing Rs.4.00 Crores. The borrower was regular in payment of the Housing Loan instalments and in course of time, the liability in the Housing Loan account came down to Rs.1.60 Crores. 

After 2 years from the date of sanction, all the loans of the borrower became NPA. The borrower requested the bank for additional loan against his housing property – either second housing loan or a mortgage loan.  The bank declined his request as it did not want to increase its exposure to the borrower.

Then, the borrower offered to close his Housing Loan and Vehicle Loan (Liability: Rs.8.70 Lakhs) and requested the bank to release the title deeds of his house.  In the meantime, the value of the land on which the house was constructed shot up and the ruling market value of the site and the house put together at that time was about Rs.9.00 Crores.  Since the house was mortgaged only for securing the liability in the housing loan account, the bank officials did not apply their mind and acceded to the request of the borrower, because they thought they could close two NPA accounts without any compromise and there were other securities available to cover the remaining loans.

But all the other loans of the borrower continued to be NPAs with the aggregate liability in them at Rs.11.00 Crores.  These loans were secured by agricultural lands (not commercial land) on which the borrower had his manufacturing facility located inside a shed with asbestos roofing and plant and machinery that have become obsolete in course of time.   There were some non-moving stocks and there were no proper records maintained for the Trade Debtors.

The major mistakes committed by the bank ‘A’ were  -

(a)  It did not pool up all the securities so as to cover all the loans;

(b)  It did not get the house valued afresh by an approved engineer, without blindly going by the original cost of the house (in case of housing loans, revaluation of the housing property every 2 years is not mandatory), before releasing its title deeds and

(c)  It failed to appreciate the fact that sale of agricultural land will not be possible under SARFAESI Act, 2002.

Bank ‘B’ while approving the CDR package of a borrower, released one security against the cash payment of substantial amount by the borrower.  Even though the value of the other securities available was sufficient to cover the remaining liability, as they were located in a remote area and there was no proper access available, they could not be sold for want of a suitable buyer.  Without examining this aspect, one good security in an urban centre was parted with by the bank.

12

Right to Recompense

While drafting the sanction terms and conditions for an approved CDR, the lending bank must be in a position to make a realistic assessment of the situation and fix the probable time limit for the borrower to earn sufficient profits to start repaying the bank debts.   Accordingly, the bank must specify it has the ‘right to recompense’ to make good the sacrifices made by it, once the company becomes healthy after rehabilitation.  This must be explained in clear, unambiguous terms.

For example, the lending bank must state it has got the right to –

(a)  Demand pre-payment of some loans viz. FITL and short term loans

(b)  Accelerate the repayment of Term Loans

(c)  Restore higher margins as per the terms of original sanction

(d)  Charge compound interest, in place of simple interest, from a particular date in future

(e)  Increase the Rate of Interest, in tune with the original sanction

(f)   Demand additional securities

(g)  Exercise its right to convert some of the company’s debts into equity

(h)  Exercise its right to appoint the bank’s representative on the board of the company

The bank may even stipulate a condition that dividends cannot be paid by the company out of its future profits, unless the loss/sacrifice made by the bank in the past is made good.

However, care shall be taken that by exercising the ‘Right to Recompense’, the company does not become sick again.  Therefore, the bank must show patience and study the situation at regular intervals of time, before taking any crucial decision in this matter. 

Every decision taken by the bank must be communicated to the borrower in writing and his acknowledgement obtained, before going ahead with its implementation.