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Mumbai: Indian Overseas Bank (IOB)’s move to write off bad loans by using its share premium account could be used as a precedent by other banks who are under the Reserve Bank of India (RBI)’s prompt corrective action (PCA) process, said experts.

In a notice to the stock exchanges late on Thursday, IOB said that its board had approved using the Rs7,650 crore in its share premium account to write off its accumulated losses worth Rs6,978.94 crore. The board decision will now be put to vote at an extraordinary general meeting (EGM) on 30 January.

“Considering that write-offs are coming at the expense of minority shareholders, we are anticipating a stormy EGM, but the resolution would pass. It took almost two months in securing all regulatory approvals and convincing them that this was the only step left to clean up the balance sheet. No other fundraising could have worked and capital infusion from government could have violated minimum public float of 25%," a person close to the development said, declining to be named.

The bank has used provisions of the Companies Act, accounting norms, banking regulations and precedents from previous rulings of the National Company Law Tribunal (NCLT) and high courts to propose write-offs at the cost of equity shareholders, he explained.

R. Subramaniakumar, chief executive of IOB, did not answer calls seeking a comment.

The Companies Act, 2013, allows the use of shares in premium accounts for five reasons. They include issue of bonus shares, buyback of securities and writing off other expenses. The Banking Regulation Act, 1949, allows other uses of share premium accounts.

“While the legal framework perhaps allows it, it is certainly an unusual step. Operational losses should ideally be set off against revenue or distributable reserves first, followed by capital reserves. We believe that distributable reserves would have turned negative if these losses were adjusted against them. This would have impacted the bank’s ability in paying coupon on the loss-absorbing AT-1 bonds, which ideally should have been the one taking losses. My worry is that it may set a bad precedent and other loss-making banks may also follow suit," said Saswata Guha, director at Fitch Ratings.

Currently, 11 state-owned lenders, including IOB, IDBI Bank, Allahabad Bank, Central Bank of India, UCO Bank and Bank of India, are under RBI’s PCA because of their weak financial health as bad loans soared and return on assets turned negative. A fall in capital levels below the regulatory prescription can also lead to initiation of PCA.

Executives at Allahabad Bank, Central Bank of India, Bank of India and UCO Bank did not respond to messages seeking comment.

“As of now, there is no development on this issue in Bank of Maharashtra," said a senior executive, who asked not to be named.

PCA forces banks to step up recoveries of bad loans, reduce risky loans, strengthen capital base and restrict branch expansion, among other measures, in order to improve balance-sheet health.

Proxy firms say that as long as there is transparency, governance is not being compromised.

“Whenever there are too many bad loans, banks have to provision for them aggressively and it usually comes at the cost of shareholders either from the general surplus or share premium accounts. This is what is happening in the case of IOB too," said Shriram Subramanian, founder and managing director, InGovern Research Services, a proxy advisory firm.

“As long as there is transparency and adequate disclosures, then to my mind there are no governance issues. The bank should at every point disclose whether these are final write-offs or write-offs with possible non-performing asset (NPA) recovery in the future," said J.N. Gupta, founder at Stakeholder Empowerment Services, another proxy advisory firm.

jayshree.p@livemint.com

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