RBI's new experiment

Borrowers' cash flow holds key to tackling stressed assets

The debt restructuring scheme announced on Monday is the latest in a series of attempts by the Reserve Bank of India in the last couple of years to tackle the menace of stressed assets of the banking sector. It started in December 2014 with a relaxation that allowed banks to extend the maturity of loans given to infrastructure companies for up to 25 years under the so-called 5/25 scheme. Six months later, a strategic debt restructuring scheme was announced, which gave banks the option to convert part of the debt of a company into majority equity and force a change of ownership. These measures worked, but only up to a point, prompting the central bank to come up with yet another scheme that now seeks to give some relief to banks, which are grappling with about Rs 6 lakh crore in stressed loans (with the prospect of more to come), and their corporate clients, which are finding it difficult to keep their heads above water. To reduce the incremental stress on existing loans, the new scheme allows banks to split the stressed loan accounts into two categories - a sustainable portion that banks deem repayable by borrowers on existing terms and the remaining portion that a borrower is unable to repay. The latter can now be converted into equity or convertible debt, giving lenders a chance to eventually recover funds if and when the borrower is able to turn around its business.

That the scheme has been thought through is evident from the fact that banks can rework their stressed loans under the oversight of an external agency, thereby ensuring transparency while also protecting bankers from undue scrutiny by investigative agencies. To help restore the flow of credit to critical sectors such as infrastructure and steel, the new scheme also eases credit lending conditions, which have become adverse. There are some caveats, too. For example, banks are not allowed to offer any moratorium on repayment on the sustainable part of the debt. For the other portion, banks will need to set aside higher provisions to the extent of 20 per cent of the total outstanding amount or 40 per cent of the amount of debt that is seen as unsustainable, whichever is higher. These provisions are higher than the 15 per cent that banks make for a non-performing asset, but lower than the 100 per cent in provisions required over a three-year period.

However, it's anybody's guess whether the scheme can have the desired results at a time when there is no noticeable demand pick-up in the economy. In the context of high debt continuing to drag their fortunes, will companies be able to service even the sustainable part of the debt with their current cash flows? In fact, the combined interest payment outpaced operating profit growth for many of India's top business houses for the fifth consecutive year in financial year 2015-16, and it is a fair assumption that the situation has deteriorated further since then. The dominant view, therefore, is that while the new credit conditions will improve the viability of companies, which have operating assets and a larger portion of sustainable loans, the unsustainable portion of the loans, which gets converted into equity, leaves the promoter with little skin in the game as a major part of the shareholding will be with the banks. The risk also is that increased supply of equity shares because of conversion of unsustainable loans could lead to a decline in market prices of such shares, resulting in immediate mark-to-market losses for banks - something the relatively weaker banks would find a cause for additional stress. Overall, however, the latest RBI scheme is an experiment worth trying at a time when banks are struggling to dispose of many stressed assets they have already acquired.