Banks offered reprieve on classifying bad loans to COVID-hit sectors

• Issues fresh guidelines to banks asking them to exercise judgement when determining NPLs

The Central Bank last week sent fresh guidelines to banks to be followed when classifying loans as non-performing, as there are sectors, which are still suffering from direct restrictions on their businesses, due to the pandemic. 

To this end, the Bank Supervision Department of the Central Bank issued a circular to licensed banks, asking them to exercise judgement when determining whether such facilities should be categorised as ‘Stage 3 facilities’, a term used in the International Financial Reporting Standard 9 for non-performing loans (NPLs). 

“In the case where direct temporary restrictions on economic activities are in place, due to the COVID-19 outbreak, the licensed banks may exercise judgment on a case-by-case basis, to determine whether to classify facilities as Stage 3 facilities or not, considering the borrower’s inability to revive the business and generate sufficient cash flows to repay the exposure, once the restrictions on economic activities are removed,” the Bank Supervision Department said in an amendment to Circular No. 04 of 2018, on ‘Guidelines to Licensed Banks on the Adoption of Sri Lanka Accounting Standards – SLFRS 9: Financial Instruments’. 

The Monetary Board, at the onset of the pandemic in late March, issued fresh directions to the licensed banks to hold off collecting instalments up to six months on loans of a wider swath of borrowers, whose incomes were affected due to the months-long economic shutdowns triggered by the pandemic. 

A practice identified as moratoriums on loans’ capital and interest was extended by a further six months for those who are engaged in the tourism sector, effective from October 1, 2020, as there was no end in sight for the travel restrictions for foreign visitors, as the virus scare stayed and now appeared to making a return. 

Such loans subjected to moratoriums were neither categorised as NPLs nor provided for possible bad loans, as banks were given instructions to hold off recognising them as part of their stressed loans. 

However, as most of the loans are now coming off from the moratoriums granted earlier, except for tourism, the banks are now required to subject such loans for regular impairment calculations and the non-performing loans, depending on which stage they get classified into. 

While the ‘expected credit loss’ method under the IFRS 9 categorised loan impairments under three stages, primarily depending on the days in arrears, the Stage 3 loans are the non-performing loans, as they are 90 days or more overdue since their instalments fell due.  “Licensed banks shall with the approval of the board of directors of the bank include clear guidelines on staging of loans and advances for impairment purposes in the related policies, amidst the extraordinary circumstances caused by the COVID-19 outbreak,” a new guideline that was incorporated last week into Circular No.04 of 2018 read. 

Meanwhile, the Central Bank also asked the banks to exercise similar judgement on a case-by-case basis, when classifying a restructured facility under Stage 3 or not, “if a facility has been restructured more than twice, due to the adverse economic consequences of the COVID-19 outbreak or Easter Sunday attack”. 

According to the original Central Bank guidelines, a loan restructured twice or more should be classified as a Stage 3 facility or NPL.