Loan restructuring is a process in which borrowers facing financial distress renegotiate and modify the terms of the loan with the lender to avoid default. It helps to maintain continuity in servicing the debt and gives borrowers a certain degree of flexibility to restore financial stability.
Regardless of whether it is done in-house by the commercial banks or through a central agency, usually, the restructuring plan constitutes a revised loan agreement. The following are some of the concessions a commercial bank can give to entice a customer to resume servicing a bad account: –
- A new repayment schedule
The loan monthly repayment is determined by the length of the repayment period and is normally calculated to amortize the loan evenly throughout that repayment period.
the bank can vary the repayment schedule of the loan to reduce the size of loan repayments. This improves borrower liquidity and enables additional cash flows to finance important operations. The expectations is that if operations pick up then the borrower will be able to meet its debt obligations in the long run.
- Interest Holiday
The commercial bank can also allow the borrower to service only the capital amount of the loan for a specified period after which he resumes servicing both capital and interest. This has the effect of improving liquidity of the borrower and may translate to improved performance and ability to pay debt obligation in future.
- Deferral or Extension of Principal and/or Interest Payments.
Extensions or deferrals are largely used to help borrowers overcome temporary financial difficulties, such as loss of job, medical emergency, or change in family circumstances like loss of a family member
- Capital holidays
This is similar to the interest holidays except that the customer is allowed to service interest only for some time. Once the borrowers financial health improves substantially, then he can resume servicing both capital and interest.
- Interest waivers
To ease the cash flow burden of the borrower, the commercial bank may decide to writeoff accumulated accrued interest on the account. The bank may even go further and forego interest as the customer pays only the capital amount.
Like in the case of interest, the bank can decide to waive all charges levied on the customer both in the past and in the future (probably with the exception of legal fees).
- Additional facilities to the customer
Providing additional facilities occurs only in the very rare situation where the banker is certain the business will be able to pull and regain health otherwise it would be like “throwing good money after bad money”. The bank assumes the risk of new losses and assumes that new loans to the same client will enable that client to settle in an orderly manner all his obligations in the future. The client will pay interest on his old loans with the new loans. However, if the client remains bad, the problem of bad assets will reoccur in even greater magnitude
Quite often, distressed borrowers negotiate with their bankers that their overdraft facilities be converted to term loans. Hence they not only benefit from an extended repayment period but also avoid many penalties and charges associated with overdraft excesses
- Reduction in the principal of the original loan agreement
In many cases, the most effective way for banks to minimize their losses on existing loans may be to renew or extend loans beyond the original plan. In other cases it may make sense to restructure the loan terms. As with any commercial credit, these renewals, extensions, or restructurings must be based on sound underwriting standards and must be subject to normal loan classification rules.