It is happening again for the Indian banking sector, especially for state-owned lenders. As the government makes yet another attempt to revive the troubled state electricity boards (SEBs), it is preparing to seek concessions from the banking sector.

Banks may be asked to convert three-fourths of their outstanding loans to power distribution firms into state government bonds and reduce the interest rate on remaining loans, Mint reported on Tuesday. That way the interest burden on SEBs will diminish, allowing them to make fresh investments and purchases.

For banks, the risk on the stressed loan assets will reduce as the states guarantee repayments. They can set aside a lower amount of capital for such loans, which are seen to be risky. So, even as the yields fall (assuming bonds are issued at a coupon rate of 8%), banks will make notable savings on capital, which should result in better return on equity (RoE), analysts said.

While the argument sounds plausible, it is not without costs. Banks currently charge 12-14% for SEB loans. A 1% reduction in interest rate on 4 trillion in SEB loans comes to 4,000 crore. Even if banks cut interest rate by 1% on a quarter of the loan outstanding, the loss of interest income will be 1,000 crore.

“Banks will have to forego interest income to some extent," said Nitin Kumar, analyst at Prabhudas Lilladher Pvt. Ltd.

According to Religare Capital Markets Ltd, reduction in interest rate can impact margins of public sector banks.

Analysts said the reduction in asset quality risk makes up for the margin concerns. But as Daljeet S. Kohli, head of research at IndiaNivesh Securities Pvt. Ltd points out, due to their government ownership, loans to SEBs can never truly turn bad. So, Kohli questions, where is the asset quality risk?

The details of the proposed package haven’t yet been released. But a mere conversion of loans into bonds will not be a permanent solution. A similar exercise in 2012 did not yield the desired results. The package provided liquidity relief, but losses at the participating SEBs did not come down as the states failed to curtail transmission losses and fully rationalize tariffs.

There is still a sizeable gap in SEBs’ average procurement costs and revenue realization. According to Crisil Ltd, the gap between realization and cost would have “almost closed" if the states were able to curtail the distribution losses.

To overcome this problem, the government has stipulated rules in terms on time lines in filing and implementation of the tariff orders and reduction in transmission losses.

But according to Girish Kadam, vice-president, corporate sector ratings at ICRA Ltd, adherence to such rules is low right now and states need to implement the conditions more seriously. While that points to structural problems, a financial package for SEBs is not a zero sum game as is being made out to be.

The writer does not own shares in the above-mentioned companies.