Loan Restructuring

All you need to know about restructuring of loans, the new RBI mandate, and the difference between loan scheduling and restructuring

Before delving into the new RBI mandate, it is essential to understand what loan restructuring is.

Although loans mandate a specific repayment term, due to certain circumstances, such as the on- going pandemic, borrowers find it difficult to repay their loan along with the interest rate. In such circumstances, rather than letting borrowers default on their payments, banks and other financial institutions with the help of the government can allow for changes that make repayment easier

Loan or debt restructuring simply refers to making changes in the existing loan terms for the borrower in order to manage the repayment of loan principal and interest due. This is not to be confused with loan refinancing which will be explained later. Generally, providing the option for loan restructuring is preferred as it also prevents the loan from being classified as a non-performing asset for which banks have to set aside provisions, which in turn reduces their profit. Additionally, it is also less expensive than allowing the defaulter to declare bankruptcy.

How Does the Process of Loan Restructuring Work?

Loan restructuring is possible through multiple ways such as:

  • Change in the repayment period which is usually extended
  • Variation in the repayable amount
  • Changes in the number of instalments that were previously agreed upon
  • A change in the rate of interest previously charged
  • Provision for additional loans

In certain cases, the time due for settlement payments can exceed a period of three months.

RBI’s Loan Restructuring Rules and Regulations

In light of the COVID-19 pandemic that caused an upheaval in the economy worldwide, the Reserve Bank of India (RBI) announced loan restructuring that would enable lenders to restructure the loans of all borrowers who may be unable to repay due to the pandemic. This restructuring will allow them flexibility based on the agreement with their banks on either rescheduling their loan payment, or on lowering of interest rates, or they receive a limited loan repayment holiday i.e., a pause on the loan repayment. The good news is that restructuring is available for almost all retail loans such as personal loans, top-up loans, home loans, education loans, car loans, etc.

Loan Restructuring Eligibility Criteria and Other Restrictions

This one-time restructuring is available for loans where the blanket moratorium of six months got done on 31 August, 2020. However, there are certain additional conditions as well. Based on the information from RBI’s circular, only loans that weren’t in default for over 30 days as on 1March, 2020 will be eligible. MSME borrowers, financial service providers who have outstanding loans of less than Rs.25 crores, farm credit, and loans to government bodies are not eligible. Additionally, loans to Primary Agricultural Credit Societies (PACS) or the Farmers’ Service Societies (FSS) for the purpose of lending to agriculture are also not eligible for restructuring.

Additionally, banks may allow a further moratorium of up to two years or even extend the outstanding tenure of the debt to reduce the EMI. The outstanding interest accrued during the said moratorium period will be converted to another loan depending on the borrower’s repayment capacity. It is to be noted that the actual process of restructuring will differ from bank to bank depending on the guidelines prescribed by their boards. In case borrowers wish to avail restructuring for their loans, they will have to apply before 31 December, 2020, although certain financial institutions may have a different due date such as the State Bank of India (SBI) which has decided on 24 December, 2020 as the last date to apply.

Apart from the above, in order to apply for relief, the borrower will have to be affected by the Covid pandemic such as having a salary or income reduction in August 2020 as compared to the amount received in February 2020; suspension or reduction of salary during the lockdown period; loss of job or closure of business, etc. Borrowers will have to note that the criteria for eligibility of borrowers may vary from bank to bank.

The RBI has allowed all private banks, public banks, foreign banks that operate in India, local area banks, small finance banks, regional rural banks, state co-operative banks, primary (urban) co-operative banks, district central co-operative banks, other Non-Banking Financial Companies (NBFCs), housing finance companies, and other all-India financial institutions to utilize this facility.

Documents Required to Apply for Loan Restructuring

The following documents will have to be submitted or uploaded (if applying online)

  • Salary slips for the month of February 2020 and the latest salary slip
  • A declaration of estimated income or salary after the end of the moratorium period
  • In case of job loss, a letter of discharge from the company
  • Account statements (salary account or operating account) from February 2020 until 15 days before the submission of application
  • Declaration of business being affected due to Covid-19 in case of self-employed businessmen or professionals

Please note that the documents required may vary from bank to bank or other financial institutions

Impact of Loan Restructuring on Credit Score

While loan restructuring may provide a much needed relief for borrowers, it is not happy news all around as one’s credit scores and eligibility will get affected because while lenders are allowed to retain such loans as ‘standard’ which will lower their Non-Performing Assets or NPAs, restructured loans have a negative impact on the borrowers’ credit scores.

It is to be understood that even if the borrower has applied for only one loan to be restructured, the lender will report all loans of the borrower’s as restructured. Restructured loans are generally reported under the ‘settled’ or ‘written off’ section and these are sometimes looked at by lenders as wilful default. However, since this is a unique situation, it is difficult to estimate just how severely a borrower’s credit score gets affected. Previously, banks were allowed to restructure loans only once they turned into NPAs.

However, although borrowers who wish to restructure their loans may not be able to prevent their credit scores from being affected, they can work towards improving the same.

Loan Restructuring vs. Loan Refinancing

A lot of times the terms loan restructuring and loan refinancing tend to be used interchangeably which is not right as they both have different meanings.

While loan restructuring is making changes in the existing loan terms to help borrowers and lenders, loan refinancing simply refers to availing a separate loan to pay off an existing loan. Loan refinancing is usually opted for if the new loan comes with better terms and interest rates. This also helps borrowers increase their liquidity to help them monetarily

If the borrower has refinanced with a loan that comes with a lower interest as compared to the existing one, the monthly payments may be lesser. However, it can come with its own set of problems as well. Loan refinancing can be expensive and unless managed well, the debt payments may spiral out of control. Therefore calculating all the expenses, interest payments, and factoring in difficult financial situations such as a job loss before availing this option is prudent

Both loan restructuring and loan refinancing can benefit both lenders as well as borrowers based on the terms agreed upon. Therefore selecting an option that best suits the borrower’s requirements and financial situation is necessary.

Loan restructuring is an option that is not always available and varies on a case-to-case basis. However, due to the economic impact of the pandemic, the RBI has made a one-time restructure possible. Borrowers must carefully assess their financial situation and future requirements prior to selecting this option. While loan restructuring comes with a lot of benefits, understanding the process and discussing with their lender regarding the steps most suited for their situation is highly recommended.