Compliance Management in Credit Portfolio- Plan your strategy-Part VI

Mandatory Covenants

While advising sanction of credit facilities, banks issue mandatory covenants , which are general guidelines to be complied by the obligor. These are general safeguards to protect the interest of the bank subsequent to the disbursement. Following are the restrictions mentioned by the banks at the time of allowing credit facilities:

• The borrower should maintain adequate books of accounts, as per applicable accounting practices and standards, which should correctly reflect its financial position and scale of operations and should not radically change its accounting system without notice to the Bank. The borrower should submit to the Bank such financial statements as may be required by the Bank from time to time in addition to the set of such statements to be furnished by the borrower to the Bank as on the date of publication of the borrower’s annual accounts. Bank will have the right to examine at all times the borrower’s books of accounts and to have the borrower’s factories inspected, from time to time, by officer(s) of the Bank and / or qualified auditors and / or technical experts and or management consultants of the Bank’s choice.  Cost of  inspection shall be borne by the borrower. After provision for tax and other statutory liabilities, unless expressly permitted otherwise, the Bank will have a first right on the profits of the borrower for repayment of amounts due to the Bank.

• In case of default in repayment of the loan / advances or in the payment of the interest thereon or any of the agreed installments of the loan on due date(s) by the borrower, the Bank and / or the RBI will have an unqualified right to disclose or publish the borrower’s name of the name of the borrower / unit and its directors / partners / proprietors as defaulters/ wilful defaulters in such manner and through such medium as the Bank or RBI in their absolute discretion may think fit.The Bank will have the right to share credit information as deemed appropriate with Credit     Information Companies (CICs) or any other institution as approved by RBI from time to time. The borrower will utilise the funds for the purpose they have been lent.  Any deviation will be dealt with as per RBI guidelines. In the event of default, or where sings of inherent weakness are apparent, the Bank shall have the right to securitize the assets charged and in the event of such securitization, the Bank will suitably inform the borrower(s) and guarantor(s).

• The borrower should not induct into its Board a person whose name appears in the wilful defaulters list of RBI / CICs.  In case such a person is already on the Board of the borrowing company, it would take expeditious and effective steps for removal of that person from its Board.  Nominee directors are excluded for this purpose. In the event of default in repayment to the Bank or if cross default has occurred the Bank will have the right to appoint its nominee on the Board of Directors of the borrower to look after its interests. In stressed situation or restructuring of debt, the regulatory guidelines provide for conversion of debt to equity.  The Bank shall have the right to convert loan to equity or other capital in accordance with the regulatory guidelines.

• The Borrower shall keep the Bank informed of the happening of any event likely to have a substantial effect on their profit or business; for instance, if, the monthly production or sales are substantially less than what had been indicated, the borrower shall immediately inform the Bank with explanations and the remedial steps taken and / or proposed to be taken.  Any change in the borrower’s capital structure where the shareholding of the existing promoter(s) gets diluted below current level or 51% of the controlling stake (whichever is lower), will attract  prior permission of the Bank (’ prior notice of 60 days  shall be required).  In case of limited liability partnerships and partnership firms ‘promoters’ would mean managing partners for the purpose of this covenant. Promoter’s shares in the borrowing entity should not be pledged to any Bank / NBFC / Institution without our consent.

Prior approval of the lending bank is an essential prerequisite for undertaking any of these activities. In case of non compliance bank has the right to restrict credit facilities.

• Formulate any scheme of amalgamation or reconstruction. Undertake any new project, implement any scheme of expansion / diversification or capital expenditure or acquired fixed assets (except normal replacements indicated in funds flow statement submitted to and approved by the Bank) if such investment results into breach of financial covenants or diversion of working capital funds to financing of long-term assets. Invest by way of share capital in or lend or advance funds to or place deposits with any other concern (including group companies); normal trade credit or security deposits in the ordinary course of business or advances to employees can, however, be extended.  Such investment should not result in breach of financial covenants relating to TOL/Adj. TNW and current ratio agreed-upon at the time of sanction. Undertake any trading activity other than the sale of products arising out of its own manufacturing operations.  (Not applicable in case finance is for trading activity only).

• Enter into borrowing arrangement either secured or unsecured with any other bank, financial institution, company or otherwise or accept deposits which increases indebtedness beyond permitted limits, stipulated if any at the time of sanction. Undertake any guarantee or letter of comfort in the nature of guarantee on behalf of any other company (including group companies).Declare dividends for any year except out of profits relating to that year after making all due and necessary provisions and provided further that such distribution may be permitted only if no event of default / breach in financial covenant is subsisting in any   repayment obligations to the Bank. Create any charge, lien or encumbrance over its undertaking or any part thereof in favour of any financial institution, bank, company, firm or persons.Sell, assign, mortgage or otherwise dispose of any of the fixed assets charged to the Bank.  However, fixed assets to the extent of 5% of Gross Block may be sold in any financial year provided such sale does not dilute FACR below minimum stipulated level.  (Not applicable for unsecured loans).Enter into any contractual obligation of a long term nature or which, in the reasonable assessment of the Bank, is detrimental to lender’s interest, viz. acquisitions beyond the capability of borrower as determined by the present scale of operations or tangible net worth of the borrower / net means of promoters etc., leveraged buyout etc.Change the practice with regard to remuneration of Directors by means of ordinary, remuneration or commission, scale of sitting fees etc. except where mandated by any legal or regulatory provisions.Permit any transfer of the controlling interest or make any drastic change in the management set-up including resignation of promoter directors.

• Repay monies brought in by the Promoters/ Directors / Principal Shareholders and their friends and relatives by way of deposits / loans / advances.  Further, the rate of interest, if any, payable on such deposits / loans / advances should be lower than the rate of interest charged by the Bank on its term loan and payment of such interest will be subject to regular repayment of installments to term loans granted / deferred payment guarantees executed by the Bank or other repayment obligations, if any, due from the borrower to the Bank.The borrower shall keep the Bank advised of any circumstance adversely affecting the financial position of subsidiaries / group companies or companies in which it has invested, including any action taken by any creditor against the said companies legally or otherwise.

• The borrower shall deal with our bank / banks under consortium / multiple banking arrangements exclusively, shall not open current account/s with any other bank without our prior permission.  The borrower’s entire business relating to their activity including deposit, remittances, bills / cheque purchase, non-fund based transactions including LCs and BGs, Forex transactions, merchant banking, any interest rate or currency hedging business etc. should be restricted only to the financing banks under consortium / multiple banking arrangement. No commission to be paid by the borrowers to the guarantors for guaranteeing the credit facilities sanctioned by the Bank to the borrowers.Approach capital market for mobilizing additional resources either in the form of debt or equity.

The aforesaid restrictions are prohibitive in nature , which are referred when there are aberrations. In normal course of business banks may not have any such mechanism for surveillance on general covenants. However information is available through various sources such as  provider of  regulator clearance in  case any change in civil structure , board composition etc. Inter departmental coordination with various government agencies providing such approvals may not exist. In such cases bank have to depend on the undertaking.  Many of these covenants may not  be of any value once the account is impaired. 

A major reason for such alienation is compliance orientation without realizing the practical issues in business. Entrepreneurs are always industrious persons who  explore opportunities for growth & development. It is the responsibility of the banker to make them realize the practicability. In either case two way interactions are  necessary. There is a shift in banking from field to desk, primarily due to shortage of people as well as data availability through system. It is to be realized that control cannot be possible without adequate field visit and interaction with the people handling the business at their place of work.

It is to be realized that while computer has replaced manual operation in banking, it is time that more time is spent in fields to understand the business which is being financed,  to realize the issues at the field level, to obtain market information as well as understand the attitude of the borrower. Effective compliance require a close understanding of the constraints faced by the obligor and possible ways of addressing the issues. In many occasions it is observed that the promoters depend upon certain consultants/ employees who are basically coordinating with the bank to obtain the sanctioned limit. The promoters or the people running the business may not be aware of the implications of utilizing, say short term sources for  long term use or entering in to some structural modifications without taking bank in to confidence. Instead of discussing with person who may not take interest of promoter’s  long stability ,interaction with bank officials may bring more benefit. While visiting the work place it is necessary to interact with the people at work, to learn more of the attitude of the entrepreneur. Information received early about weakness may be useful in taking proactive step to control exposure. Inculcation of a risk culture is an essential prerequisite for risk management. The people at the desk must realize the recourses available to bank, the rights and responsibilities of each functionaries and the status of the borrower at any point of time. This is possible if  the assignments are clearly defined and each play their role effectively. It is difficult to drive a car. One has to look at the windshield, back mirror, clutch, break, gear , signals , signs in the road etc. But we must drive the car to reach the destination. We have to learn how to develop a system of managing compliances , which are essential tool for protecting the interest of the lender.