Reserve Bank of India vide its circular dated 12 Nov 2021, has clarified the modalities for implementation of Out of Order concept in respect of interest servicing aspect of working capital loans. In brief, as per RBI guidelines, “the interest debited in the account during last 90 days period as on reckoning date should be serviced by eligible credit transactions of the account within the same look back period of 90 days.”
Brief of RBI Guidelines
- Working capital loans is the product created for meeting the running cash requirements of the customers. Customers are expected to draw the funds as and when required for meeting the cash flow requirements and deposit the receivables in the account as and when received. Therefore, drawing a specific schedule for repayment of Bank’s funds is not possible. Accordingly, as per guidelines, the customers are expected to generate minimum credit side turnover in the account so that at-least interest debited in the account is serviced in next 90 days period and exposure remains healthy as Standard.
- As per RBI guidelines, interest servicing is expected to be implemented based on cumulative period of past 90 days running window.
- Accordingly, consideration of past credit transactions to off-set future dated interest demands is permitted by RBI.
- Therefore, systems implementing the IRAC norms need to maintain the data points for date wise interest debited and credit transactions received in the account.
The illustration of the same is given hereunder:
- Processing date: 31/03/22
- Look back Period: 90 days
- Look back start date: 01/01/22
- Interest Transaction Date: 31/01/22
- Interest Transaction Amount: Rs 1200.00
- Next Interest Transaction Date: 28/02/22
- Next Interest Transaction Amount: Rs 1300.00
- Next Interest Transaction Date: 31/03/22
- Next Interest Transaction Amount: Rs 1500.00
- Credit Transaction Date: 31/03/2022
- Credit Transaction Amount: Rs 4500/
As per illustration above, it may be noted that the interest debited during last 90 days period (total Rs 4000) is serviced on the day of processing from the credit transaction of Rs 4500 and accounts meets the interest servicing criteria as per IRAC norms. However, the point worth noting here is that credit transaction dated 31/03/2021 which is considered for off-setting interest demand for look back period will also qualify for consideration to off-set the interest demand for next 90 days period since the credit transaction of Rs 4500/ on 31/03/2022 is eligible to be considered till 28/06/2022 as a look back period and if the interest debited till 28/06/2022 is less than Rs 4500 and also there are no credit transactions in the account till 28/06/2022 and the account will remain standard. Thereby, a single transition is being considered twice for off-sitting business rule evaluation, which is apparently an anomaly and requires review on part RBI to address the same suitably.
Points of Consideration
In view of above, following points are relevant and needs review.
- While implementing the guidelines as illustrated in above example, a credit transaction can be utilized for two windows, one 90 days look back period and 90 days of forward window. As illustrated in above example, the account, has a credit transaction as on 31/03/22 which is being used for servicing interest from 01/01/22 to 31/03/22 window as the same 31/03/22 dated credit transaction will be considered to offset interest demand for a window of look back period from 31/03/2022 to 28/06/2022 even if no credit transaction is received during this period and apparently the account will meet the interest servicing criteria of out-of-order concept. Therefore, a credit transaction is serving for 180-days period whereas theoretically should serve only for 90 days period as a single transaction may serve two concurrent windows of 90 days period. which is apparently an anomaly and require review on part RBI to address the same suitably.
- Secondly, the predicting a Standard facility as NPA on a future date (Potential NPAs) on account of interest servicing default is uncertain. Since, transactions are cumulated for look back period, therefore it is not possible to predict future transactions and predicting future NPAs. For example, If we consider above illustration, the credit transaction of 31/03/2022 for Rs 4500 is sufficient to serve the interest demands to the extent of Rs 4500 till 28/06/2022 even if there is not credit transactions till 28/06/22, however, since the asset classification is being done on daily cycle, therefore as on 29/06/2022 the customer will suddenly become NPA, since the credit transaction of 31/03/22 will be out of look back window as on 29/06/2022. Therefore, close monitoring of working capital exposure may become complex at business level from asset quality perspective and controlling expected NPAs.
Therefore, apparently the guidelines in this case need discussions and review at appropriate level. From author’s point view, implementation of FIFO model of interest servicing is more suitable methodology which takes care of the issues under reference. The salient features of suggested model are as under:
- The FIFO model will ensure that interest debited as on a date is serviced by onward eligible transactions in the next 90 days.
- Past credit transactions should not be consumed for servicing future interest dues.
- Potential NPAs identification will easy and straight forward.
- The customer will be more proactive in maintaining the health of the account by ensuring interest servicing by future dated transactions instead of leveraging the single transaction amount for -180 days.
My purpose of writing this blog is to bring the issue in public forum so that as many experts can throw their views and if necessary, the regulator can take necessary action, if required. There is no intention of criticising or demeaning of anyone whatsoever.