The Reserve Bank of India (“RBI”) has raised the alarm over the widely practised but controversial practice in the lending industry—‘renewal or rollover of loans’. In a recent directive, the RBI called on microfinance lenders to cease the practice of rollover and netting off, which results in loan evergreening. In September 2024, the RBI extended its scrutiny to gold loan providers, mandating a comprehensive review of their practices and requiring an action report within three months. 

After the crackdown on excessive lending rates, the RBI’s focus is now shifting to the practice of loan renewals, which has long been criticised for masking credit risk and delaying necessary financial restructuring. In this article, we discuss the concept of loan renewal, its regulatory framework, implications of the RBI’s advisory, potential concerns and the way forward for lenders.

Understanding Loan Renewals

Loan renewals give borrowers an extension on repayment timelines, often right before the due date. To put it simply, the borrower (usually close to the repayment date) would apply for a new loan (or a top-up loan) or seek an extension of tenure of the existing loan (rollover) based on the facility made available by the lender. The lender would accordingly record either a closure of the existing loan account and creation of a new loan in its books or a revision of the repayment date. 

Why are Loans Renewals preferred?

Loan renewals where a lender rolls over or renews a loan instead of calling it due—can have certain short-term benefits for both borrowers and lenders, though they also raise significant concerns from a regulatory and long-term financial health perspective. Here’s why this practice is adopted by borrowers and lenders:

Benefits for Borrowers:

• Relief from Repayment Pressure: For borrowers, particularly those facing temporary financial difficulties, loan renewal can provide immediate relief by extending the repayment period. This allows them more time to repay the loan without defaulting, which could otherwise result in penalties, higher interest rates, or legal action.
• Avoidance of Default or Loss of Collateral: By rolling over a loan, borrowers can avoid the consequences of default, such as loss of assets (in the case of secured loans like gold loans), damaged credit ratings, and the potential for legal actions that may follow non-payment.
• Access to Additional Funds: In some cases, lenders may offer additional funds along with the rollover of the original loan, allowing borrowers to meet additional financial needs. This is particularly common in sectors like microfinance and payday loans, where borrowers may rely on short-term credit to meet ongoing cash flow needs.

Benefits for Lenders:

• Reduced Risk of Default: By renewing or rolling over loans, lenders may avoid the potential losses associated with defaults. As long as borrowers continue to make minimum payments or adhere to the renewal terms, lenders maintain a flow of income from interest payments, thereby reducing the risk of non-payment.
• Lower NPAs – A loan is classified as a non-performing asset (NPA) when the borrower fails to make principal or interest payments for a specified period (typically 90 days). If a borrower is unable to meet the repayment schedule but is given a fresh loan or a rollover, the lender does not have to classify the original loan as an NPA, even though the borrower may still be struggling financially. Instead, the loan is either treated as a fresh loan with a new repayment schedule or the repayment date of the existing loan is revised, and the lender can continue reporting it as a performing asset.
• Interest Accumulation: With loan renewals, lenders can extend the interest-bearing period of the loan, potentially increasing the total amount of interest collected over the life of the loan. This can be a profitable arrangement, especially in high-interest lending environments.

Regulatory Framework with respect to Loan Renewals

The RBI guidelines do not define rollover or renewals, however, a reference to the practice of renewal or rollover is made in the Master Direction – Reserve Bank of India (Non-Banking Financial Company – Scale Based Regulation) Directions, 2023 (“SBR Directions”)¹. The SBR Directions define ‘restructuring’ as: 

“A restructured account is one where the NBFC, for economic or legal reasons relating to the borrower’s financial difficulty, grants to the borrower concessions that the NBFC would not otherwise consider. Restructuring shall normally involve modification of terms of the advances/securities, which shall generally include, among others, alteration of repayment period/repayable amount/ the amount of instalments/rate of interest (due to reasons other than competitive reasons). …. In other words, extension or deferment of EMIs to individual borrowers as against to an entire class shall render the accounts to be classified as ‘restructured accounts’.”

A similar definition has also been provided under the RBI circular on ‘Prudential Framework for Resolution of Stressed Assets’ dated June 7, 2019 (“RBI Circular 2019”)².

Loan Renewals vs Restructuring

Restructuring is a targeted facility designed to help lenders support borrowers facing genuine financial distress and prevent defaults. It is meant to be a need-based measure implemented during times of financial stress.

In contrast, loan renewals are typically extended to most customers, regardless of their financial circumstances or the existence of any underlying difficulty. Given that loan renewals are offered indiscriminately to most customers, they technically fall outside the purview of restructuring.

The following table draws out the difference between loan renewals and restructuring in detail:

Are Loan Renewals Barred? 

The RBI has acknowledged the practice of loan renewals in various guidelines but has not specifically barred the practice of loan renewals. However, the regulator issued targeted directives on loan renewal to microfinance and gold lending players driven by pressing concerns. The regulator’s outlook on loan renewals can be understood through the following:

1. As an exception to the definition of restructuring, the RBI guidelines specifically allow rollover of short-term loans by NBFCs with an asset size of less than INR 500 crores. The same is not considered as restructuring if it is done with proper pre-sanction assessment and based on the actual requirement of the borrower and no concession is provided due to credit weakness of the borrower. In case the account is rolled over more than two times, then the third rollover is treated as restructuring.³

2. In its circular dated September 30, 2024 (“RBI Circular 2024”), the RBI has highlighted multiple practices that the RBI considers as irregular, including:⁴

• Lack of a specific identifier for top-up gold loans in the core banking system/loan processing system with the lender mostly to facilitate the evergreening of loans. Absence of fresh appraisal at the time of sanctioning these top-up loans.
• The practice of rolling over loans at the end of loan tenure, with only part payment.
• Non-categorisation of gold loans as NPA in the system, evergreening by renewing overdue loans/issuing a fresh loan, etc.

3. In addition to the above regulatory guidelines, the RBI officers have, in the past year, voiced their concerns about evergreening practices in various public interactions as well.

The Regulator’s Concerns

Loan renewal requests were typically made close to the repayment date, raising doubts that such requests were merely a strategy to disguise the actual NPAs and inflate the loan disbursement reporting. This raised concerns about the transparency of financial reporting and the potential for misleading figures in the lender’s books.

The line between ‘a facility for borrower’s convenience’ and ‘an instrument to evergreen loans’ increasingly became difficult to discern. What may seem like a convenient option for borrowers became a mechanism to hide systemic asset downgrades, jeopardising the integrity of NPA reporting and amplifying systemic credit risks. 

What’s next?

Given that a large section of borrowers relies on the loan renewal facility and manage their cashflows expecting the renewal facility to be available, a sudden halt on this practice may result in a sharp rise in NPA reporting. As an immediate impact, mass downgrading of credit scores may also be expected, driving some customers to disengage. Resultantly, lenders may face customer dropouts and a reduction in loan disbursement volumes. Lenders will have to build a larger customer base to achieve similar lending volumes. This, in turn, could lead to increased cash turnovers and a faster churn of the loan cycle.

It appears that the regulator intends to restrict facilities of loan renewals or extension of repayment timelines only for borrowers facing genuine financial difficulties. In such cases, these facilities ought to be targeted relief provided to the borrower considering the borrower’s financial difficulties (rather than as a general product feature). This is specifically allowed under the restructuring framework, subject to asset classification downgrade and increased provisioning. While it may help the borrower facing financial difficulties, the lender would still be required to report NPAs. This will address the regulator’s concerns about inaccurate NPA reporting. Operationally, lenders may find it difficult to evaluate each borrower’s financial condition and extend the renewal facilities. 

While loan renewals may seem to provide temporary benefits, they can ultimately lead to financial instability for both borrowers and lenders. For borrowers, it can trap them in a cycle of debt, as they may never fully pay off the loan, whereas for lenders, it can mask the true financial health of the borrower base, leading to increased credit risk and a potential build-up of NPAs that could harm the lender’s long-term financial standing.

The RBI’s growing concerns over these practices urge greater transparency and stricter lending standards to prevent over-leveraging and ensure that credit is extended in a sustainable and responsible manner. The practice is increasingly seen as a way to artificially sustain lending business, which may not be in the long-term interest of either party.

Way Forward

The RBI’s advisory on loan renewals currently targets specific lenders in sectors where this practice is most common. However, should high volumes and similar patterns continue, we suspect guidance may be issued across the sectors as well. 

Lenders must proactively review their internal policies to assess potential risks associated with their practices being considered evergreening. It is imperative for lenders to anticipate the potential impact of a shift in their loan renewal policies, should new directives be issued. 

[1] Appendix III-B to Annex III of SBR Directions

[2] https://www.rbi.org.in/Scripts/NotificationUser.aspx?Id=11580&Mode=0

[3] Para 3 of Appendix III-B of Annex III to the SBR Directions.

[4] Annex, RBI Circular 2024.