COVID-19 and Default of Commercial Loans: Looking Ahead
The time we are living in is unprecedented, to say the least. While claims relating to health, social and political unrest are undeniable, the economic disaster that we are facing now or will be facing in the future is worrying. The experts are unanimously predicting that there will be substantial employment cuts across most sectors in the aftermath of the pandemic and the affected countries will face a sharp decline in economic prosperity. It is predicted that Bangladesh will not be immune from this catastrophe either. The World Bank's report suggests that Bangladesh's gross domestic product growth will fall from last year's 8.15 percent to 2 percent by the end of this financial year (June 30), with the highest growth range peaking at a mild 3 percent.
At this rate, many companies and other corporations will face massive losses and will be forced to wind up their businesses, or declare bankruptcy. The inevitable result will be a rise in default of loan repayments. To combat this situation and to aid the failing businesses, Government intervention will be of utmost importance. The Government of Bangladesh is very much aware of this economic challenge and, through its actions, has taken an aggressive approach in its fight to keep our economy afloat. The Hon'ble Prime Minister has already declared generous stimulus packages to be distributed through the Bangladesh Bank and several initiatives have also been taken by the Bangladesh Bank to support businesses to navigate through these troubling times. Some of the noteworthy steps include, inter alia, declaration of stimulus packages for helping the export-oriented businesses to pay wages to their workers, credit provided to service-oriented businesses at a subsidised rate to be used as working capital, credit provided to small and medium enterprises (SMEs) with nominal interest, creation of a refinancing scheme in the form of a special incentive for the agricultural sector, and so forth.
It is felt, however, that a more aggressive approach may be taken by the Bangladesh Bank to address the problems which will be faced by the borrowers in repaying their loans. It is clear that ailing businesses will need utmost assistance from the Bangladesh Bank in the current financial climate. As part of its crisis mitigation strategy, the Bangladesh Bank, by exercising its powers under the Bank Companies Act 1991, has already directed all scheduled banks not to downgrade the classification of any borrowers for defaulted loans between the period of 1 January 2020 and 30 June 2020. Additionally, by exercising its powers under the Financial Institutions Act 1993, the Bangladesh Bank has also directed the financial institutions to do the same. In a nutshell, these initiatives by the Bangladesh Bank have led to a status quo on credit classification which has to be maintained by the scheduled banks and financial institutions during the said period. This is undoubtedly a helpful step taken by the Bangladesh Bank which will aid the defaulting borrower's situation given the current circumstances and the looming crisis. However, it is suggested that, in order to effectively mitigate the impact of COVID-19 on the borrowers and, resultantly, the economy, the Bangladesh Bank may consider announcing a more robust regulatory package. Among other measures, the regulatory package may allow for a specific moratorium on the repayment of debt, relaxation of certain norms for working capital facilities, and so forth.
Apart from a stay on credit classification (as mentioned above), the Bangladesh Bank may also consider offering a moratorium to the ailing borrowers on their loan repayments. A moratorium can be termed as a payment holiday, which allows the borrowers to defer due payments for a specified period. In simple terms, the effect of a moratorium will be that if any bank or financial institution in Bangladesh grants a moratorium to the borrower, then the borrower will not be required to pay the loan amount due to such a lender, during the moratorium period – thereby giving the borrowers the much needed "breathing space".
The moratorium shall defer all instalments, including the interest payable during the moratorium period for all the term loans, and all of the interest accumulated during the moratorium period can be paid at the end of the repayment schedule. For working capital facilities, the moratorium will only suspend the interest payment during the moratorium period, and the interest accrued during this period shall be payable after the end of the moratorium. In this way, the borrowers can concentrate on focusing to keep their businesses afloat and retaining their employees rather than going on a spree of employment cuts and lay-offs. It is believed that this may not have a massively adverse effect on the bank's profits as well because, consequently, the repayment schedule for such a loan account will be extended and the amounts payable during the moratorium will, in any event, be repaid during the said extended period. This proposal has also been suggested by the World Bank and has already been introduced by our neighbouring country India, where the Reserve Bank of India (RBI) has permitted all commercial banks, including regional rural banks, co-operative banks, all-India financial institutions, non-banking finance companies and housing financing companies to grant a moratorium for up to 3 months on the payment of all principal, interest and repayment instalments (between 01 March 2020 and 31 May 2020) to their borrowers for all term loans, including credit card dues.
Apart from a moratorium, by exercising its powers under the Bank Companies Act 1991, the Bangladesh Bank can also direct the scheduled banks not to trigger the default clauses under the loan agreements. Typically, a financing facility provides for a material adverse effect, popularly known as 'MAE', as a trigger for an event of default. The banks generally negotiate an expansive definition of MAE which includes any event that has a materially adverse effect on the business of the borrower. Undoubtedly, COVID – 19 has already brought large swaths of the world's economies to a grinding halt through the lockdown, and the financial markets have almost entered the recessionary territory. As a result, the future cash flows of many businesses will get negatively impacted, which may trigger MAE in a financing facility, subject to its terms and conditions. Generally, the banks do not favour a 'force majeure' clause in their financing documents, since it may allow a borrower to avoid its payment obligations. In the absence of an explicit 'force majeure' clause, which should squarely cover a situation like COVID-19, the borrowers will be left to argue an implicit 'force majeure' clause – thus increasing disputes and litigation between the parties. A clear guidance from the Bangladesh Bank may certainly avoid such a situation.
Another important area where the Bangladesh Bank can provide some valuable assistance to the ailing borrowers is the valuation of assets kept as security. The COVID-19 pandemic has already upset the stock market, with recession looming large. All these factors have a cascading impact on the valuation of assets. In a secured financing transaction, the security package may have a variety of assets such as shares, immovable properties and moveable assets. If the security depletes, a bank can typically ask a borrower to replenish the security. If the borrower fails to replenish the security, it will constitute an event of default, which entitles the bank to accelerate repayments under the facility and enforce any security.
Since most of the assets kept by the borrower as security will devalue, unless the Bangladesh Bank intervenes or gives proper guidance, the banks will be at liberty to sell these assets at the reduced value and then claim additional security from the borrower for their remaining loan amounts – thereby creating more pressure on the ailing businesses. Recently, an Indian High Court restrained a bank from selling the promoter's shares, in the current crisis, which have been pledged to the bank as security. In this case, the borrower argued that the shares of the company plummeted as the financial markets dipped on fears of the COVID-19 pandemic. In this context, the Indian High Court held that the borrower required protection from such enforcement acts during such disrupting times and barred the sale of the pledged shares. The case is ongoing and it will be interesting to see if such a precedent is set and whether other courts will follow suit.
Lastly, due to increasing defaulting loans and the dangers of being declared insolvent, the Government of Bangladesh may also consider a temporary suspension of the insolvency provisions contained in our relevant Companies Act and insolvency statutes. For the time being, this step may shield businesses against insolvency proceedings from their creditors. Recently, the Government of India has already announced, as part of their incentive-package, an increase in the threshold limit of default for triggering the corporate insolvency resolution process to protect businesses from unwarranted insolvency proceedings. Furthermore, the Government of India has also suggested that if the COVID-19 crisis continues beyond 30 April 2020, the Central Government may suspend certain provisions of their insolvency laws for a period of 6 months to shield businesses against insolvency proceedings from any creditor.
In this time of crisis, the steps that have already been taken by the Government of Bangladesh under the leadership of the Hon'ble Prime Minister are certainly praiseworthy. It is believed that if the above steps are also taken by the Government of Bangladesh (if not done already), then such actions will be timely and will go a long way to help keep businesses afloat during this pandemic and in its aftermath.
The writer is the Head of Firm of Sattar&Co. assisted by his research associate, Nafiz Ahmed.