DSCR & ICR Explained: How Banks Assess Loan Covenants in India

DSCR — Debt Service Coverage Ratio

DSCR = Net Operating Income (EBITDA – Taxes) ÷ Total Debt Service (Annual Principal + Interest)

DSCR measures whether the cash generated by operations is enough to cover both the interest and the principal repayment due in a period — the full annual loan instalment, not just the interest portion. It is the single most-watched ratio for term loans and project finance because it directly answers the lender's core question: can this borrower actually make the scheduled repayments from operations, without needing to refinance or sell assets?

Worked Example

At 1.42x, this borrower has ₹5 Cr of headroom above its debt service — comfortable against a typical 1.25x covenant, but an EBITDA decline of ~15% would bring DSCR down to the covenant floor.

ICR — Interest Coverage Ratio

ICR = EBITDA ÷ Interest Expense

ICR is a narrower measure than DSCR — it only checks whether operating profit covers the interest cost, ignoring principal repayments entirely. It's commonly used for working capital facilities (cash credit, overdraft) that don't have a fixed amortisation schedule, and as a simpler "early warning" covenant alongside DSCR on term loans.

Using the same example: ICR = 20.0 ÷ 4.0 = 5.0x — well above the typical 3.0x covenant, even though DSCR (which also counts principal) was a tighter 1.42x. This is why a business can be "ICR-safe" but "DSCR-tight" — interest is a much smaller bite than the full repayment schedule.

The Covenant Package — What Else Lenders Track

What Happens If You Breach a Covenant

A covenant breach is technically an "event of default" under most Indian facility agreements — even if every EMI and interest payment has been made on time. This surprises many borrowers, because the loan "feels" current.

• Lender's typical first response: Request explanation, additional MIS/reporting, and a remediation plan
• Waiver: Lender can grant a one-time or temporary waiver, often for a fee (waiver fee, typically 0.25-1% of facility amount)
• Covenant reset/amendment: Renegotiate the covenant level if the breach reflects a structural change (e.g., a one-off impairment), usually with a fee and possibly a rate increase
• Penal interest: Some agreements specify an automatic rate step-up (e.g., +1-2%) upon breach, regardless of payment status
• Restricted actions: Dividend payments, further borrowing, or capex above a threshold may be frozen until the covenant is cured
• Acceleration (worst case): In severe or repeated breaches, the lender can demand immediate repayment of the entire outstanding loan

How to Improve DSCR and ICR

• Grow EBITDA — the numerator for both ratios; operational efficiency and margin improvement directly help
• Refinance to extend tenure — lowering the annual principal component improves DSCR (though increases total interest paid)
• Reduce total debt — pay down high-cost debt first using surplus cash; directly improves leverage and coverage ratios
• Improve cash conversion — a business with strong EBITDA but weak operating cash flow may report healthy ratios on paper while struggling to actually fund the repayment — fix working capital first
• Negotiate moratorium/step-up structures — for businesses in a growth investment phase, structuring lower principal repayments in early years (with step-ups later) can keep DSCR within covenant during the ramp-up