A few days into the country’s first national lockdown in March, the Reserve Bank of India judiciously stepped in to help mitigate a potential crisis in the financial sector by permitting banks and NBFCs to grant a moratorium on interest and principal repayments for term loans and working capital facilities provided to all categories of borrowers. This moratorium was timely as it provided a significant relief to all those borrowers whose cash flows were severely disrupted due to the virtual cessation of economic activities on the back of a stringent nation-wide Covid lockdown from the last week of March. Given the continuing virulence of Covid-19 and the persistence of lockdown in most parts of the country, RBI, in the last week of May, permitted the lenders to extend the moratorium by another 3 months from June to August 2020.

Initially, confusion was rampant in the financial sector on whether non-bank lenders such as NBFCs and microfinance institutions (MFIs), were eligible for a moratorium on their own borrowings. The banking industry, weighed down by sizeable bad loans and modest capital adequacy levels, partly used their discretion to provide the moratorium facility. Many NBFCs, meanwhile, found themselves in a spot because they had to offer a moratorium to their customers but a similar relief was not being provided to them, which led to potential asset-liability and cash-flow mismatches. This led RBI to quickly issue a clarification that banks and non-banks should extend the facility to all, unless a borrower decides to opt out of it. But it was only after the NBFCs took the matter to court and raised the issue with RBI, in May, bankers started to consider the moratorium requests of NBFCs and MFIs on a case-to-case basis; again, not before they carefully assessed their existing credit quality.

Mostly, public sector banks stuck to the RBI mandate and adopted an ‘opt-out strategy’, in which retail and SME customers were automatically offered the moratorium unless they informed the bank or NBFC otherwise. In the case of private banks, corporate borrowers were expected to approach them with requests for the moratorium which was to be assessed on a case-by-case basis, while the ‘opt-in’ strategy was deployed mostly in the retail segment, asking borrowers to confirm if they want to defer their loan payment.

In the first phase of the moratorium, private banks disclosed that one-third of the loan books went under the moratorium, while state run lenders had a higher proportion of borrowers who availed of this facility. While there are no official figures available in the public domain, it is estimated that around 30%-45% of the aggregate portfolio in banks and NBFCs were under moratorium in the first phase. Yet, the proportion of such borrowers under moratorium has been steadily declining in the second phase of the moratorium which commenced from July 2020. The latest feedback from the bankers indicate that currently only 20%-25% of the advances are under moratorium. While the estimates may be higher for the NBFCs, the latter’s proportion has also been on a decline.

Clearly, the declining trajectory of borrowers under moratorium is an encouraging sign although the revival of the economy is still some distance away. While salaried retail borrowers with continuity in their jobs were never expected to avail the moratorium in the first place, it is evident that an increasing share of self-employed borrowers and SMEs who have seen a partial revival in their businesses, have opted out of the moratorium. This also reflects the noteworthy efforts made by both banks and NBFCs to increase the borrower awareness regarding the accruals of interest charges and higher indebtedness that arises from the moratorium. The longer the moratorium period, the larger the accumulation of interest dues and more importantly, the unpaid interest gets added to the outstanding principal and raises the debt burden substantially. In the case of retail EMI loans, such accrued interest will lead to a significant extension of either the loan tenure or the EMI amount, both translating into higher payouts. For corporate term loans, however, the accumulated interest on term loans have to be settled through monthly instalments till March 2021.

Undoubtedly, the impact of the pandemic has been severe and a relief to the vulnerable borrowers was necessary. In our view, the moratorium has served its purpose well for a period of six months. However, any further extension of the moratorium may start to have adverse implications on financial discipline among the borrower community. It is important that the borrowers across all categories should resume servicing their debt to the extent that they are capable of based on their cash flows rather than continuing with a full deferment. Another risk of providing a continuous moratorium to borrowers with relatively better liquidity position is the likelihood of diversion of surplus funds which otherwise can be used for debt repayment. We, therefore, would not be in favour of any further extension of the six-month moratorium.

Nevertheless, we also need to acknowledge the challenges that some of the vulnerable sectors of the economy will continue to face over the next 1-2 quarters given the incidence of intermittent lockdowns across different parts of the country and a weak demand scenario. In particular, it is clear that sectors such as hospitality, retail, transport, aviation and leisure will take a significantly longer time to resume and revive their operating cash flows. Further, a certain section of self-employed retail and SME borrowers may require further support on debt servicing.

We, therefore, believe that a one time restructuring of loans can be permitted in specific sectors or specific borrower categories to address the challenge of weak cash flows till the economy revs back to its normal mode. Such a loan restructuring will involve a realignment of the scheduled principal and interest repayments in line with the expected operating cash flows not just in the near but also over the medium term. Unlike the existing norm of downgrading such restructured accounts as NPAs, RBI can provide a special dispensation of maintaining their standard account status if the restructuring is completed within specific timelines and only to address stress arising from the Covid lockdown. In order to ensure that there are no undue risks generated from the restructuring of standard accounts, some level of provisioning can be made mandatory as has already been done for those under moratorium. In our opinion, a one-time restructuring is a more prudent option at this stage when the economy is a partial recovery mode rather than a blanket moratorium. It will also partly mitigate the risks of another sharp spike in bad loans in the domestic financial system amidst a weak economic environment.

Experts and the financial markets have valid concerns on the asset quality of banks and NBFCs post the expiry of the moratorium since it is apparent that the economic revival process will take a longer time. Intermittent lockdowns continue to disrupt the activities not only in the vulnerable sectors but also in many small businesses and self-employed borrowers, impairing their repaying capacity. Apart from collapsing demand, labour shortage and supply chain disruption continue to lead to income losses in these segments. However, a blanket moratorium extending into several quarters may not be an ideal way to tackle this challenge. A targeted one-time restructuring mechanism, in our view, is a longer-term solution to this crisis and will allow adequate time to the severely impacted businesses and borrowers to come up the curve while at the same time, not burdening the lenders immediately with another wave of bad loans.