Why new debt recast scheme is like a nuclear deterrent
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The new strategic debt restructuring norms released by the central bank on Monday are like a country’s nuclear deterrent: great to have, messy when used.
Still, in a country where a bankruptcy law is largely confined to a paragraph in the Union budget speech and indignant op-ed columns by retired bankers, it is indeed a welcome move that the Reserve Bank of India (RBI) is arming lenders to take steps against wilful defaulters.
Large companies often get away with murder, dictating terms to lenders simply because of the sheer size of their borrowings. Now, with the potent threat of ownership and management likely to be snatched away, this could keep them on their toes. Firms will be more cooperative with lenders, say for instance, more willing to sell assets to pare debt. This will generally improve the level of corporate governance and, in theory, shareholders should also benefit.
Indeed, this should have been made a law three years ago when the asset quality problem started to deepen, but better late than never. Despite rosy gross domestic product numbers (which the government itself is re-examining now), the stresses on the economy haven’t disappeared. Impaired assets (including recast loans) will rise to 13% of total advances by March 2016, according to credit rater Fitch. The ratio was 10.73% at the end of December.
But like a nuclear weapon, it seems more effective as a threat because of several hurdles in applying the law. Taking over the ownership of a large firm will work for banks as they can find buyers. But there is a danger of there being few takers for small companies.
Secondly, after conversion, the value of equity might be far lower than the outstanding debt. One out of every three listed companies (excluding banks and finance companies) are trading at a market capitalization below their fiscal 2015 debt levels.
Thirdly, as independent analyst Hemindra Hazari points out, such wilful defaulters would have defrauded not only banks but other entities such as the state (taxes, statutory dues, etc.) and employees. If banks become the new owners, they would be left holding the can to pay these statutory dues which take precedence over debt.
Moreover, at the slightest whiff of banks wanting to convert debt to equity, they should be prepared for a barrage of suits filed by existing promoters to delay the process.
Note also that impaired assets are largely concentrated in a few industries such as metals, power etc. How much concentration risk will the banks be willing to take?
These are questions that will be answered only when the law is actually applied. Everyone is waiting for the first test case. While it is a welcome law, investors aren’t too excited. Re-ratings based on this move are still some time away.