Lender of Last Resort for the Borrowers and Critical Financial Illness Cover

Over the years, I have dealt with many cases that included stressed assets also. In case of stressed assets when the stress starts reflecting in the account, it starts creating some sort of panic to the lenders. Situation becomes like this that at one end, the borrowers struggles with its liquidity issues, and on the other end, the lenders struggles with the borrower to recover their dues/loans. Many of such stressed cases undergo Debt Restructuring. Under restructuring, generally most of the borrowers seek additional funding from the existing lenders in order to cope up with the liquidity issues. However, none of the lenders, generally by Heart & Soul is ready to extend such additional finance. Such additional finance is extended only at the minimum level and after lot of follow up by the borrower. Many of the times, such additional funding comes very late by which time situation (financial troubles, liquidity) becomes grave for the borrower.

This scenario forces us to think that when there is a borrower facing genuine difficulties then why the additional finance (a kind of nursing solution) is generally not available or available after hell lot of follow ups and not on right time (a patient needs Oxygen on right time, isn’t it!). In case of bankers, if any of the bank faces any liquidity issues, the regulatory authority (i.e. Reserve Bank of India) stands as the lender of last resort for them. Why is such lender of last resort is not available to the borrower who can take the responsibility and act like a lender of last resort for the borrowers?

I would like to bring attention in this direction towards IRBI. The Industrial Reconstruction Corporation of India Ltd. was set up in 1971 for rehabilitation of sick industrial companies, and was reconstituted as Industrial Reconstruction Bank of India (IRBI) in 1985. Later on, IRBI was converted into Industrial Investment Bank of India Ltd. (IIBI) in March 1997 to offer a wide range of products and services. In 2006-2007 it was decided to close IIBI. In light of the above thoughts for specialized needs of the stressed companies, perhaps now there is much deeper experience gained over the years which justify the need of an IRBI type of institution on a long term basis for supporting the restructuring needs of corporates, and who can perform some sort of lender of last resort role for such companies.

As an alternative, it also forces us to think about a solution for the borrowers to have an arrangement of a critical financial illness event funding available as an immediate finance in the form of insurance cover for protection from the financial illness a borrower may face in future. Such types of critical illness insurance protections are available to the individuals from the Life Insurance companies. This leads us to the idea of having lenders/insurers/agencies/product available in financial markets with an obligation to extend immediate finance on triggering financial stress (or some other types of events which leads to the requirement of restructuring) event at the borrower. Such type of product would come at the cost of premium to be paid by the borrower. Such critical illness cover may be triggered on happening of events like LC Devolvements, frequent Overdrafts requirements, losses reaching to a particular pre-decided level, etc. and the other signs reflecting stress situations illustrated in the RBI guidelines on Framework for Revitalising Distressed Assets in the Economy.

I would like to mention here about the existence of Credit Default Swap product for protection of the lenders (but not for nursing of the borrowers).  A credit default swap (CDS) is a financial swap agreement under which the seller of the CDS compensates the buyer in the event of a loan default or other credit event. The buyer of the CDS makes a series of payments (the CDS fee) to the seller and, in exchange, receives a payoff if the loan defaults. There are also products like Mortgage Insurance which compensates lenders or investors for losses due to the default of a mortgage loan.

In India, specialized insurance cover products are available to the Exporters and Banks from Export Credit Guarantee Corporation of India Ltd. (ECGC).

There is also Credit Guarantee Fund Trust for Micro and Small Enterprises (CGTMSE). This scheme seeks to reassure the lender that, in the event of a MSE unit, which availed collateral free credit facilities, fails to discharge its liabilities to the lender, the Guarantee Trust would make good the loss incurred by the lender up to 75 / 80/ 85 per cent of the credit facility.

In light of the above, the history of existence of institutions like IRBI, the availability of insurance products from ECGC/CGTMSE, product like CDS, and larger experience gained over the last 4-5 years of the specialized needs of the stressed companies, it appears that the financial markets are open to product like critical financial illness cover, and also for the IRBI type institution to act as lender of last resort for the stressed companies.