Synopsis: Loan restructuring allows borrowers to modify terms like interest rates and tenures to pay back loans under challenging economic situations. Join us as we explore how the loan restructuring process works and expert tips to make the most out of this opportunity.

According to a report by TransUnion CIBIL, there has been a 16% increase in defaulters from March 2022 to March 2023. This statistic underscores borrowers’ lack of repayment capability due to the financial crisis. To stabilize this situation, RBI has provisions for loan restructuring to aid borrowers in paying back their dues without default. Under this process, borrowers can seek any revision to the previously agreed-upon terms, such as interest rates or loan tenures. The aim is to empower borrowers to repay the credit and avoid bankruptcy while helping banks recover their investment capital to maintain economic stability. This article will cover loan restructuring in detail, including steps to start the loan structuring process and tips to make the most out of the process.

What is Loan Restructuring?

Let’s understand this from the basics. Usually, loans come with a specific repayment term. However, the borrower may find the interest rate and other payment terms challenging due to particular financial challenges. Instead of defaulting on the payment, borrowers seek help from the lender to renegotiate the terms for more manageable repayments.

If the lender agrees, both parties sign a new repayment contract for the existing loan. This is known as loan restructuring. Usually, financial institutions agree to restructure before such loans get classified under NPAs (Non-performing assets) only to reduce the lender’s profitability later. However, one must not confuse it with loan refinancing.

Loan Restructuring vs. Loan Refinancing

People often confuse loan restructuring with loan refinancing. However, both have different meanings. While the former is all about adjusting the terms of the present loan, the latter involves applying for a separate loan to pay off the current one. Also, loan refinancing is suggested when a new loan is available at a better interest rate and terms to easily increase the borrower’s liquidity. However, such loans could be expensive if not managed well. Thus, lenders need to consider various factors of borrowers, such as cumulative interest rates and projected income, before refinancing loans.

Loan Restructuring Process

The typical process of loan restructuring takes place through the following steps.

Financial self-assessment:

This is a self-assessment phase for borrowers where they realize the current loan terms are unsustainable going forward and need a new repayment structure to avoid defaulting.

Weighing options:

Now, the borrower and the lender discuss the scope of restructuring the current loan before any payments are missed.

Documentation:

To give it a try, the borrower provides the lender with necessary documents, such as income resources, profit-loss statements, and a detailed explanation of their financial hardship.

Loan term negotiation:

This is where the borrower tries to negotiate with the lender to agree on revised terms to facilitate a low-interest rate, a longer payment tenure, and other modifications to ease the payment burden.

Agreement formalization:

When both parties agree on new terms, it gets formalized with a revised contract. It is imperative for borrowers to enquire if the restructured terms could hamper their credit score and to ask for tips on avoiding that for future loans.

RBI’s Loan Restructuring Rules and Regulations

Post-pandemic, RBI changed the terms for loan restructuring to allow eligible borrowers to pay without classifying the loan under the NPA. According to the official circular, only standard loans not defaulted for more than 30 days as of 31st March 2021 got the green flag for restructuring. Also, the government allowed all retail loans, including car and education loans, to be covered under loan restructuring.

Tips for Borrowers Before Taking Loan Restructure

• Assess your financial health under the income projection of the next few years to negotiate better terms.
• Understand the different restructuring options available to choose the one that might work best for you.
• Reach out to your lender when you anticipate difficulty meeting your loan obligations.
• Ensure you fully understand the terms before agreeing to the new restructured loans.
• Consider how restructuring will affect your credit score and future borrowing capacity, not just the immediate relief.

Cautions for Lenders Before Sanctioning Loan Restructure

• Carefully assess the borrower’s financial health and reasons for financial hardship before determining if restructuring is essential.
• Ensure the restructured loan terms are within the lender’s risk tolerance.
• Ensure regulatory compliance related to loan restructuring set by the governed official is met.
• Understand how restructuring might affect the overall health of the lending portfolio.
• Post restructure approval, closely monitor the borrower’s account to ensure compliance with new terms.

 

How Does Loan Restructuring Impact Credit Score?

While loan restructuring makes loan repayment a bit easier, it might impact borrower’s credit score and eligibility for future loans.

Lenders retain loans as ‘standard’ below NPAs when a borrower opts for loan restructuring. A single restructured loan enables lenders to report the rest of all loans by the borrower to be tagged under restructured as well. As a result, these loans are considered wilful defaulting by the lender.

This doesn’t directly hamper the credit score; it just influences the decision of lenders as they see the borrower as someone who had difficulty repaying the loans in the past. However, if the lender reports a restructuring attempt of the borrower as a settlement or partial payment, it hampers the credit score. But, as the borrower successfully meets consistent payment requirements by the new terms and conditions, the credit score improves over time.

End Thoughts

The most significant advantage of loan restructuring is that borrowers can repay their loans under revised terms and conditions tailored to their unique financial situation. However, before moving ahead, borrowers must discuss the process with their lenders and acknowledge its effect on their credit score. In this regard, this guide can help MSMEs easily recognize the best practices for credit risk management.