SDR loopholes: Loan conversion may hit banks

SDR loopholes: Loan conversion may hit banks

The RBI recently fine-tuned the guidelines governing the SDR of stressed borrowers to make the system more effective, there are still loopholes.

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Reserve Bank of India

The revamped strategic debt restructuring (SDR) mechanism is hardly going to be a panacea for the debt problems of banks. While the Reserve Bank of India (RBI) recently fine-tuned the guidelines governing the SDR of stressed borrowers to make the system more effective, there are still loopholes which can create problems for the lenders with debt of close to Rs 1,00,000 crore of 17 companies already under SDR.

According to analysts, the write-off required to make SDR cases viable is 60-80 per cent of the loan and a mere 10 per cent increase in provisions is not enough. “Banks convert a part of their loan into equity under SDR and are currently exempt from creating MTM (mark-to-market) provisions. To avoid the cliff-effect of provisioning in case SDR fails, banks are now required to build up 100 per cent provisions against equity MTM losses equally over four quarters. On the balance portion of loans, banks should create 15 per cent provisions — against 5 per cent now — within the 18-month window available for finding a new buyer,” said a Religare report.

Further, the RBI has not changed norms for calculating conversion price for debt into equity. Conversion takes place at face value or fair value whichever is higher. This results in huge MTM losses at the time of conversion itself, it said. For example, Electrosteel’s Rs 2,500 crore loan is being converted at a price of Rs 10 against the market price of Rs 3.35, leading to a big loss for lenders. In fact, lenders had suffered huge losses in most of the loan conversions in the recent past.


The RBI has made it clear that the revised guidelines will be applicable prospectively. However, bankers and analysts said it would be prudent if banks follow these guidelines retrospectively even in cases where JLF has already decided to undertake SDR.


Proposing that all stressed assets should be treated as NPAs, KC Chakrabarty, former Deputy Governor of the RBI, said the definition of NPAs should be extended from the usual NNPA and restructuring should also include assets which are currently classified under alternate windows, ie, refinancing under 5:25 route, SDRs, security receipts, JLF and CAP (corrective action plan). The clean-up move is in the right direction and possibly follows the failure of restructuring window (large part of incremental NPAs are from the restructuring portfolio) and the slow pace of activities in stressed sectors of steel, power and infrastructure, he said.

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The RBI has now stated that SDR cannot be used for all defaults. “This provision should have been incorporated earlier. There’s suspicion that SDRs of some companies are questionable,” said a banking source. SDR should be evoked only in cases where a change in ownership is likely to “improve economic value and enhance the prospect of recovery” and not for all defaults.

RBI has said banks should not release the personal guarantees or commitments of old promoters till new owners are in place.

According to the Religare report, banks may end up refinancing 30-40 ailing accounts under the scheme in the next one year, thus postponing NPA recognition of Rs 1,50,000 crore, or 2.2 per cent of credit. “Banks have little scope to fully recover loans via the sale of assets. SDR invocation is not treated as restructuring for asset classification/provisioning, and thus most cases have standard restructured assets with low provisions of 5 per cent, which has now been hiked to 15 per cent. “Our analysis of 10 SDR cases invoked so far reveals that interest accruals and loss funding will push up debt by 70 per cent from first restructuring via corporate debt restructuring (CDR) until conclusion of SDR. Banks will thus have to write-off 35-95 per cent of interest (debt and equity) in FY17-18 if stressed assets find no takers. The haircut in case of a takeover will also be high, resulting in huge provisions for banks even if the SDR is successful.