RBI Revises Fair Value Diminution for Restructured Loans

6.1 In this context, it may be mentioned that prior to revision of the guidelines on restructuring of advances under CDR Mechanism issued vide circular dated November 10, 2005, the methodologies prescribed by the RBI for the computation of sacrifice by the  banks and FIs  differed.  Banks discounted   the future interest due as per the original loan agreement to the present value at a rate appropriate to the risk category of the borrower (i.e. current PLR plus the appropriate credit risk premium for the borrower category) and compared with the present value of the dues expected to be received under the restructuring package discounted on the same basis.  FIs, however, reckoned the future interest due, based on the PLR or its equivalent (rate charged to a AAA rated borrower immediately preceding the date of restructuring, if such rate was different from the announced PLR) as on the date of restructuring plus the original risk factor (risk factor applicable to the borrower at the time of initial sanction of the loan).  During the course of the discussions which the members of the Working Group to review the CDR Mechanism had with representatives of banks as part of their work,  it was represented that  methodology for computation of sacrifice(diminution) for banks should be aligned with that for FIs in order to ensure a level playing field and also in view of the fact that the difference in the present value of the interest cash flows as per the terms of pre-restructured loan and the post-restructured loan was substantial because the interest rates had declined during the last 4 to 5 years at that time.  The Working Group agreed to the suggestion, in principle, with the understanding that so long as the approach was followed consistently from year to year over the entire interest rate cycle, it would not raise any prudential issues.  Accordingly, the Group recommended to compute the diminution in the present value of the interest cash flows with reference to the “current BPLR as on the date of restructuring plus the appropriate term premium and credit risk premium for the borrower category on the date of restructuring” which was much lower than the interest rate charged on the pre-restructured loan at that time.

Reproduced for reference with acknowledgment — Source: Reserve Bank of India · RBI/2008-09/428 · issued 09 Apr 2009. The plain-English explanation above is BankPulse’s own independent summary.

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