It is an encouraging sign that the RBI and government have recognised the extent of the problems in the banking sector and are slowly trying to resolve some of them. The latest initiative, strategic debt restructuring (SDR), to allow banks to convert debt into equity and take control of companies that have not been able to meet viability milestones or other critical norms even after a loan is restructured, is aimed at putting more pressure on promoters and easing the growing burden on banks. This option could lead to a change in management and ensure more skin in the game for promoters, the RBI believes. True, this may improve the bargaining power of banks until a strong bankruptcy law comes into force.
But several structural challenges remain. For instance, hardly any Indian lender has the management expertise or capability to either run a company that has not turned around, even after successive restructuring attempts, or to identify and empower new management or a promoter to take over troubled units. Even asset reconstruction companies that buy bad loans from lenders and then make money by selling them after a turnaround, as well as private equity funds, have found the going tough. What makes it more difficult is the fact that the debt-equity ratio in many cases of lending to companies is heavily loaded against banks, which may prompt promoters of heavily debt-laden companies to welcome such forced changes in ownership and management. While technically, such a conversion of debt into equity will lower bad loans on the books of banks, it may not be a viable option and could be a drag on lenders.
At a broader level, ensuring a pick-up in both investment and consumption demand, which will lead to higher utilisation of spare capacities, and changes in state-owned banks, are far more critical. Incremental changes will only delay the pain. Unlike the last time, when Indian banks were in trouble with total bad loans in double digits well over a decade ago, this time around, they cannot rely on another virtuous cycle of a secular decline in interest rates, which helped them use treasury gains to provide for bad loans and bounce back. For the regulator, it may also be useful to look at the books of some of the private banks to check if their cleaner balance sheets are a true reflection of their risk management and operational capabilities. In short, a 360-degree view of the banking sector is called for, along with quick correctives.