RBI allows a one time restructuring of loans

• The Reserve Bank of India has permitted one time restructuring for certain COVID stressed loans. This will help manage their financials and contain the NPA pressure as the economy experiences unprecedented stress. 
• 'The Scheme is for only accounts which are in stress due to COVID 19 and only for borrowers which are not in default for more than 30 days as on the cutoff date of March 1, 2020'
• These policies introduced in the recent RBI policy focus on improving the functioning of the financial markets, support imports and exports, ease the unprecedented financial stress caused by COVID-19.

How does this impact NBFCs & Banks?

• The Gross NPAs have been on the rise across the stressed sectors. Capital intensive and high fixed cost sectors such as aviation, real estate, consumer durables, Hospitality and jewellery are  finding it difficult to repay loans, due to subdued demand, impacting the asset quality of Indian banks. 
• This restructuring will temporarily help Indian banks exposed to these sectors, and their NPAs would go down in the near-term. However, coupled with the recently announced moratorium, the pain will be most apparent when stressed borrowers may still be unable to pay back loans later, despite the restructuring. Right now all the pain seems to be brushed under the carpet! 
• 'While in the short-term there could be a fall in NPAs due to the restructuring, the NPAs are expected to rise in the longer term. According to ICRA, Gross non-performing assets (NPAs) of banks are likely to worsen to 11.3-11.6% by the end of this financial year.'
• Banks with strong capital adequacy ratio and loan books of healthy borrowers should be able to tide through these difficult times. Large banks have already braced for the worst, and provided for the Moratorium. The provisions are expected to go up even further.

How will this affect financial markets?

• Debt mutual funds--especially credit risk funds-- have seen severe liquidity and redemption pressure in the current stressed scenario. From a high of nearly Rs 80,000 crore that credit risk funds managed in April-19, the total amount managed has fallen to below ₹29,000 crore as of 11th August 2020, according to data from AMFI. The Franklin Templeton fiasco in April exacerbated the redemptions. 
• The restructuring scheme is likely to protect stressed firms from downgrades temporarily (as they will now be given a longer rope in default). However this will result in significantly higher risk in the Debt markets over the next year.

What does this restructuring mean and why is done?

• The economic fallout on account of the COVID-19 pandemic has led to significant financial stress for a number of borrowers (loan takers) across various sectors.
• The resultant stress can potentially impact the long-term viability of a large number of corporates, otherwise having a good track record, due to their debt burden becoming disproportionate. 
• These corporates, historically, have had exceptional track records. However, due to stress in the economy, caused by the pandemic, these borrowers are facing challenges in their businesses and generating positive cash flows.
• Containing a widespread impact caused by the shutdowns on loans is a prime motive for central banks to ensure banks and financial markets do not grind to a standstill. Currently the banking system is facing  significant financial stability risks.
• The Resolution Framework for Covid-19 related stress has been formed as a special window under the June 7, 2019 RBI guidelines for restructuring and allowing banks to give borrowers more time to pay back without classifying a loan as an NPA.

INDmoney Analysis

• While the loan restructuring scheme is a solid initiative by the RBI, it is pre-emptive of a significant deterioration of business environment in India.
• Banks have been shoring up capital off late via various means to build reserves to tide through the crisis. Financial institutions will go through a rough phase over the next year.
• Considering the current economic environment it is understandable as to why banks are taking a conservative approach. Credit growth in the country is at multi-year lows.
• The conservative nature is expected to continue in the short term. The high demand for government and AAA-rated bonds is the primary reason in their rally since the announcement of lockdown. The demand for these securities will remain high.
• AAA-rated and government securities with a low probability of default have outperformed every other category of fixed income securities and will continue to do so in this volatile economic environment. Therefore stick to only AAA bonds and debt funds.