Loan Covenants

How Do Loan Covenants Work?

Covenants are usually classified as affirmative, negative, or financial in nature.

• Affirmative Covenants are obligations. For example, a borrower must submit audited financial statements every quarter, especially if revenue crosses ₹50 crore.

• Negative Covenants are restrictions. For instance, a borrower may not be allowed to raise more than ₹10 crore in additional debt without prior approval.

• Financial Covenants involve maintaining specific ratios. A typical example would be a Debt-Service Coverage Ratio (DSCR) of at least 1.25. So, a business with an EBITDA of ₹2.5 crore should not have annual debt repayments exceeding ₹2 crore. Another example is maintaining a Loan-to-Value (LTV) ratio below 75 percent for loans secured by real estate.

Other Common Requirements

• Reporting Deadlines: Annual audit reports and tax filings are usually required within 90 days of financial year-end.

• Liquidity Conditions: Borrowers may need to maintain a minimum liquidity buffer, such as ₹5 crore in cash or equivalents.

• Net Worth Tests: Dividends may be restricted if the borrower’s net worth falls below a set figure, such as ₹15 crore.

Benefits of Loan Covenants

• Risk Mitigation: Lenders can reduce default risk by setting boundaries around financial behaviour.

• Early Warning System: Sudden changes in EBITDA or other key metrics can trigger discussions or restructuring before problems escalate.

• Accountability: Borrowers are more disciplined when clear financial and operational expectations are in place.

Challenges in Practice

• Restrictive Terms: Covenants may sometimes hold back growth. For example, a clause restricting capital expenditure could delay an ₹8 crore expansion plan.

• Rise of Covenant-Lite Loans: Around 90 percent of syndicated loans in 2025 have moved away from strict maintenance covenants, raising lender concerns around unchecked borrowing behaviour.

• Compliance Costs: Smaller firms often spend up to ₹2 lakh annually just to meet covenant-related audit and reporting requirements.

Conclusion

Loan covenants are more than fine print. They are a balancing act between lender security and borrower flexibility. In 2025’s dynamic lending environment, well-crafted covenants offer both protection and partnership. For borrowers, understanding and negotiating them wisely is essential for smooth and sustained access to credit.