S4A Won’t Solve The Bad Loans Problem – Finance Guru Tamal Bandyopadhyay Speaks

It’s official: The strategic debt restructuring (SDR) scheme, introduced by the Reserve Bank of India (RBI) in June 2015 to address the rising bad debt problem of the banking system, has failed.

Under SDR (which a domestic brokerage described as “a band-aid for a bullet wound” in a January report), a consortium of lenders could convert part of their loan exposure in a stressed company into equity and own at least 51% of it. The banks were given a window of 18 months to bring the houses of stressed companies in order, but they found the time period too short to get any benefit out of it.

In February 2014, RBI allowed a change in management of companies that were not able to service bank loans as a part of restructuring of stressed assets. The principle of the restructuring exercise was that the shareholders must bear the first loss and not the lenders. To give promoters more skin in the game, RBI directed the banks to explore the possibility of transferring promoters’ equity to the lenders to compensate for their sacrifices. It also said the promoters must bring in more equity into their firms and transfer their equity to a security trustee or an escrow arrangement till a turnaround is effected. It also recommended a change in ownership.

This was done after the regulator realized that the corporate debt restructuring (CDR) mechanism, put in place in August 2001, could not do much to alleviate the pain of the lenders. Any loan exposure of Rs.10 crore and more (including non-fund limits) and involving at least two lenders could have been tackled on this platform.

Under the new scheme, christened Scheme for Sustainable Structuring of Stressed Assets or S4A, the banks are being allowed to convert up to half the loans of corporations into equity or equity-like securities. Any project which has commenced commercial operations and has an overall exposure of more than Rs.500 crore, including unpaid interest, can be brought to this platform, provided the bankers are convinced that the project can service the debt in the longer run. An independent techno-economic viability study can establish this. The banks will also work under the oversight of an external agency, ensuring transparency. This agency will protect the bankers from unwarranted scrutiny by the Central Vigilance Commission and the Central Bureau of Investigation.

Unlike CDR, S4A does not allow the banks to offer any moratorium on debt repayment; they are also not allowed to extend the repayment schedule or reduce the interest rate. The conversion of part of debt into equity or qausi-equity instruments will be governed by valuation norms, prescribed by the regulator. Finally, the banks will have to set aside money for 20% of the total outstanding debt or 40% of the debt that is seen as unsustainable. This is more than what banks typically need to provide for bad loans—15% in the first year.

The gross bad loans of 39 listed Indian banks, in absolute term, rose 92% in fiscal year 2016 to Rs.5.79 trillion even as after provisioning, the net bad loans more than doubled to Rs.3.38 trillion. In percentage terms, the average gross non-performing assets (NPAs) of this group of banks rose from 4.41% of loans in 2015 to 7.91% in 2016; net NPAs in the past one year rose from 2.45% to 4.63%. Public sector banks, which have close to 70% market share of loans, are more affected than their private sector peers. Two of them have over 15% gross NPAs and an additional eight close to 10% and more. If we include restructured loans as well as those loans that have been written off, the total stressed assets could be as much as one-fourth of loans, at least for some of the government-owned banks.

Many bankers are treating S4A as manna from heaven that will immensely help them suppress the pile of bad loans, but they are probably overtly optimistic. Here are some reasons why this may not bring any dramatic change in banks’ balance sheets.

Only those projects that have started commercial production can take advantage of this scheme. There are many projects, particularly in the power sector, which have not yet started commercial production for lack of regulatory clearances and/or fuel linkages; they will remain outside its ambit.

While working on the revival package, the banks need to use the current cash flows of the concerned projects to determine the quantum of sustainable debt; they do not have any flexibility for changing the terms and conditions of the loan while drafting the scheme and even in the future. Any project functions in a dynamic business scenario and hence unless the bankers who will manage the show are able to respond to the changes in the external environment, it will be difficult to achieve commercial viability.

Also, the presumption that the conversion of debt into equity is a panacea for all ills may not be correct. In November 2010, a consortium of banks converted Rs.1,355 crore of debt of Kingfisher Airlines Ltd into equity, owning 23.21% of the airline. The promoter, too, converted Rs.648 crore of debt into equity. Still, the airline could not be saved. Theoretically, equity is a perennial liability and costlier than debt, which has tax advantages. It will be too much for the bankers to expect white knights coming to their rescue by pumping in equity capital in projects that are not sustainable. They will have to fend for themselves.

Finally, the scheme is silent about unsecured creditors such as the suppliers of raw materials. Who will protect their interest? Even after the banks decide to move ahead with this scheme, the unsecured creditors can always approach a court of law and play spoilsport. Ultimately, by being unsecured creditors, they may not get their dues, but they can certainly delay the process; the banks may lose time precious for the revival of a company and survival for themselves. S4A sounds like a car model, but the ride may not be all that smooth for the banking system.

 

 

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* This column originally appeared in Mint

About the Author:

tama

Tamal Bandyopadhyay is one of the most respected business journalists in India. Currently, he is a Consulting Editor of Mint, writes a weekly column on Mint – Banker’s Trust, which is widely read for its deep insights into the world of finance.  He is also an Adviser on Strategy for Bandhan Bank. He has authored two best sellers on finance, `A Bank for the Buck’ and `Sahara: The Untold Story’. His latest book, `Bandhan: The Making of a Bank,” a Penguin publication, is being released in June.

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