Opinion Making bad loans better

The huge overhang of bad loans has prompted the capital markets regulator, Sebi, to bring in changes in rules to allow Indian banks to convert part of their outstanding debt in listed companies into equity based on a fair price that is below the market. The move should help in two ways. One, by allowing banks to gain a controlling or dominant stake in companies that are defaulters, it could mitigate the prospects of insolvency of such borrowers. Besides, a higher equity component could mean less pressure to service debt for stressed firms and the lowering of leverage ratios, at least in the near and medium term, thus easing balance sheet pressures.

For banks in India, this opens up another avenue to ensure repayment of loans. The threat of conversion of debt into equity may work with at least some promoters who may be forced to fulfil their obligations given the threat of losing control or the prospect of a change in management or a sell-off of the company by the lenders. However, an earlier dispensation provided by the RBI for converting loans into equity was reviewed two years ago after concerns on the pricing of equity conversion, forcing the regulator to cap it at 10 per cent of the share capital of the company. But with banks struggling to recover their dues over the last couple of years, the RBI decided to look at the issue more sympathetically.

Advertisement

But the new flexibility on offer should not be used by banks to camouflage or mask bad debt — a genuine worry for regulators. RBI Governor Raghuram Rajan had said in the past that banks have to be trusted during such loan recasting efforts, which makes it all the more incumbent on them to ensure that the conversion exercise leads to gains not just for them but also all other stakeholders, including minority shareholders. From a broader perspective, the new rules will complement other measures undertaken by both the RBI and the government to address the issue of bad loans. A new-found proactive stance on the part of banks to recover bad loans, the proposed bankruptcy code announced in this year’s budget and more professionally run boards of state-owned banks should also help in the medium term to bolster the Indian banking system.`