Five pros and cons of RBI's new NPA takeover norms

While RBI has given more teeth to banks to nail wilful defaulters, not many are convinced that taking over a company is a bank's core competence

One of the biggest problems facing the economy is that bankers are unwilling to lend. Sticky nature of their existing toxic assets prevent them from taking more risk. Thus, despite three rounds of interest rate reductions announced by the central bank, there are many banks that haven't announced any reduction in interest rates.

While the bankers have provided for these bad assets and are willing to wait till the economy picks up, the government and the Reserve Bank of India (RBI) want to see a pick-up in credit. This can only happen if banks are provided more teeth to deal with non-performing assets (NPAs).

In order to tackle the NPAs, RBI has provided a mechanism to lenders to recover bad loans. The RBI has allowed banks to acquire 51 per cent or more stake in companies defaulting after restructuring their loans. The keyword here is restructured assets.

The central bank is willing to give the promoter one more chance to bring his company on track. One can excuse a promoter for painting a rosy picture for getting a loan from a bank, but if his case comes up for restructuring, he has to be more realistic of the future and how he intends to repay banks.

When a restructuring exercise is underway, a company has to agree to several benchmarks which are set in consultation between the banker and the company. RBI feels that if there is a default even after the recast, there is a case of operational/managerial inefficiencies. This becomes a good case for change in ownership as per the central banker.

However, in reality it is not as simple as it seems.

Following are five pros and cons of this latest RBI move, as seen by both sides of the divide in the banking industry. 

Pros

1) The initiative will strike a fear in the hearts of promoters from defaulting as they might end up losing their companies. Such promoters might start bringing in funds from their other ventures to keep this company from slipping away.

2) Banks will be able to clean up their books rapidly and still hold on to the asset. Banks will move the company from their lending books as loans get converted to equity. Such a conversion has also been exempted from calculation of capital market exposure and will not attract mark-to-market provisioning.

3) Change in ownership will help banks recover their money fast if the change in management brings in the desired results.

4) RBI, through this announcement, has made it clear on how the company will be valued. Since most of these companies are sick and do not have any net worth; valuation was a tricky issue. RBI said that the conversion of debt to equity will be at a fair value and should not exceed the lowest of ‘market value’ or break-up’ value. 

Market value is the average closing price of the company in the last 10 days preceding the reference date for conversion. Break-up value is the book value per share to be calculated from the company's latest audited balance sheet, adjusted for cash flows and financials after the earlier restructuring.

5) Selling such sick companies would not only help banks increase lending but also increase the output from the affected companies, thus adding to the overall growth of the economy.

Cons

1) Many argue that RBI’s policy is utopian. The central bank knows that commercial banks will not be able to run companies, especially since they did not have the foresight to avoid lending money to such companies that were going to default. Further, running a manufacturing or a services (non-financial) business is a completely different ball-game than running a bank. They are on the two opposite ends of the risk spectrum. That probably explains why RBI has advised banks to sell the stake to a new promoter ‘as soon as possible’.

2) Banks may also find it difficult to find buyers for such companies. When banks convert debt to equity at low prices (valuation), the equity capital will bloat, making it dificult to service.
 

3) RBI’s measures may work in cases where promoters are wilful defaulters. But in cases where the entire sector is in stress, there is nothing that existing promoters, bankers or the new promoters can do unless the overall economy picks up. Edelweiss, in a recent report, has pointed out that major stress to the banking system comes from iron and steel, infrastructure and textile industry. Not only are the NPAs highest in these segments but so are the slippages. Finding a brave buyer for such assets will be a difficult task.

4) A wilful defaulter is one who knows that he can bypass the system or generally has the muscle to take on the system. Snatching away his company will not be as easy as it seems. He can get bankers in a legal tangle which will delay the entire process.

5) Consider a large corporate with deep pockets which is willing to buy a company for its assets (say mines). The value at which it will be buying these assets will be ridiculously low. Share price of such defaulting companies are generally beaten down and their break-up value (which is the book value per share adjusted for cash flows and financials) would also be very low. In fact, RBI has said that if the latest balance sheet is not available then the break-up value shall be Re 1. This means that the buyer of the company will be able to get the asset at a very low cost. Banks would barely be able to recover their money, but the buyer, if he plays the capital structuring game right (merge the sick company at low valuations into its own company) would be a huge beneficiary.