Four years ago, minutes after taking over as Governor of the Reserve Bank of India, Raghuram Rajan made the now famous statement about promoters not having a divine right to stay in charge if they could not manage an enterprise. For many promoters, life has been difficult not just because of a business downturn, but also because rules of the game have changed considerably over the last couple of years. The new insolvency law that came into effect this year has seen a dozen-odd corporates being referred to the National Company Law Tribunal (NCLT) which will ensure either a quick turnaround, or closure.
The nature of the relationship between lender and borrower or debtor and creditor, especially where big business groups are involved, has long been skewed in favour of the borrower. This situation now looks set to change.
Earlier this month, the securities market regulator, Sebi, unveiled a new rule under which listed firms will have to publicly disclose, within one working day, any default on a bond or loan that it commits, either in local or international markets, or on any other securities. Such defaults were hitherto not made public — banks cited confidentiality agreements entered into with borrowers as the reason — and credit rating agencies, therefore, often fell behind the curve.
The new rule, which comes into effect from October, will potentially trigger behavioural changes among banks, firms and investors.
India’s bankers have been used to even some of the better names stretching the concept of working capital liquidity by making interest payments, in many cases, up to 89 days after the due date — just in time to ensure that the loan does not turn ‘bad’ (mandatory when interest or instalment on the principal remains unpaid for 90 days or longer). Often, fresh funds are lent to group firms to prevent a loan from being classified as a bad loan — a practice that is known as “evergreening”.
Such quiet arrangements between banks and borrowers could be put to test in the new regime — unless lenders, especially among the private banks, design new ways to escape the regulator’s gaze and game the system. The new rule should impose a higher degree of credit discipline on both the borrower and the bank to prevent an early default. This is because a public disclosure of even a small default can impact not just the company’s stock, but also its ability to raise capital in the future. It will mean a downgrade by credit rating agencies, with implications for the cost of borrowing.
For banks, it should indicate a much closer monitoring of loans or credit. For investors, the rule change will provide an early opportunity to assess the risks of staying on, and help them cut losses rather than holding on to a lemon without any way to recover their funds.
The rule change should also make it more difficult for promoters or businessmen to nudge bankers to go easy on repayments. The real test of this new preventive measure to stem the build-up of bad loans already aggregating Rs 8 lakh crore will come after October. In the current business cycle, with many firms struggling, the frequency of downgrades with each public disclosure of a default should logically be higher. That is something the regulators should be looking at closely.
It seems apparent that the top financial regulators are working to ensure that listed banks have to now disclose publicly the reason for the divergence of over 15% in the numbers furnished by them and the one reached by the banking regulator after inspection. Three private banks, including two leading ones, have figured in such a list. It casts doubts on the integrity of accounts, the role of audit committees, and the boards of the banks, and leaves investors with the apprehension of more bad news. Elsewhere, when the integrity of financial accounts is violated, punishments are swift. Indian regulators haven’t come down as hard on such practices as their global peers. The P J Nayak Committee, which reviewed the governance of bank boards, suggested a way forward: levying of penalties through cancellation of unvested stock options, clamping down on monetary bonuses for the top management and full-time directors, and directing the chairman of the audit committee to step down from the board of the bank.
As the global experience shows, cleaning up banks can be a prolonged and painful affair. It will be a test of political resolve — especially because not enough jobs are being created and existing jobs are being threatened with more companies being referred to the insolvency forum — besides governance, integrity and regulatory capacity. During the last such cycle over 15 years ago, when too, an NDA government was in power, the pedal was eased as soon as the recovery started. For years after that, the can was kicked further down the road. Doing that again may be difficult.