Loan restructuring for SMEs: What you should know

The Covid-19 induced pandemic has created many economic uncertainties, especially for the MSMEs. RBI governor Shaktikanta Das in his speech back in May 2021, had identified MSMEs as “the most vulnerable category of borrowers”. True enough, the road to recovery has been rocky and at times directionless for this sector. To lessen the severity of its impact, RBI had introduced Resolution Framework 2.0 for Covid related stressed assets. This essentially allowed banks to restructure loans with the intention to help the borrower.

What is loan structuring?

When a business faces a financial crisis and is unable to pay an existing loan under the previously agreed-upon terms, one of the most sought-after processes that they usually opt for is loan restructuring. Here the lender makes the term of the loan more flexible and affordable for the borrower, which in turn helps them to avoid any default.

But there is a cost attached.

Nothing comes without a cost. Loan restructuring can provide temporary relief but by default implies an increase in the overall loan obligation. If the borrower’s income channels remain impacted for a long time, the restructuring adds to the pressure. The loan repayment tenure is extended by the lender to lower the EMI amount, as a result of which the borrower ends up paying a lot more due to the snowballing effect of interest rates. Many experts have categorically highlighted that loan restructuring should only be opted for, as a last resort. When a borrower has a loan remarked as restructured, it automatically sends out a red flag to the credit underwriters — which in turn makes it difficult for the borrower to raise further debts. Restructured loans need to be reported by the lender to the credit bureau and the loan account itself will be termed as “Restructured” in the credit report. The account then goes through deeper scrutiny to ensure the borrower’s repayment capabilities. This has already become a reality for borrowers who had opted for a loan restructure. They’re finding it increasingly difficult to raise further debts. To avoid such a situation, the ideal path to follow will always be to avoid opting for restructuring of a business loan unless there is a proper repayment plan for the restructured loan. Having said that, in a situation where borrowers have already opted for it — there are a few financial maintenance rules that they can follow. These rules will not help in avoiding deeper scrutiny but it certainly provides the lender some assurance in terms of the borrower’s credibility.

The rules are:

1. Timely repayment of loans: It may sound obvious but on-time payments act as the brightest indicator of a good borrower.
2. Being regular with GST payments and ITR filings: These records are proof that the borrower has been regular with his income and payments.
3. Ensuring that the actual status of the loan is reported to CIBIL by the lender.

Digital solutions can be of great help in this regard. When it comes to credit assessment, lenders usually have to go through a lot of data to evaluate the application. If the borrower already uses digital solutions like a unified cash flow management system that helps in connecting all financial and transactional data, digitally — it further helps the borrower to maintain a clean record and provides the lender the ability to evaluate better. Loan restructuring is really the last resort for a borrower when there are no other options like reducing expenses or selling or mortgaging assets. But if it is a step that as a borrower one needs to take then be sure to move forward only with a proper repayment plan and ensure that your other financial health indicators are in check.