Where are the default disclosure norms, Sebi?
One of the most important things the Securities and Exchange Board of India (Sebi) can do to help tackle the bad-loan mess is to notify norms for disclosure of defaults by listed companies. It will nudge borrowers to behave better and will have a significant effect in preventing another Rs10-trillion bad-loan pile-up after another decade.
The rule itself is simple: if you are a listed company and have defaulted on any bank loan, disclose it to the stock exchanges the next working day. 0n 4 August, the capital markets regulator released a circular notifying this norm for listed firms only to defer it a day before it was to kick in.
Predictably, borrowers kicked up a fuss, saying that there are “technical” defaults; there are different kinds of loans, sometimes they miss payment dates because of cash flow issues and Sebi rules don’t define a default and so on. Banks, too, weren’t far behind in raising objections; their immediate concern seems to be that such disclosures will impact the overall credit rating of the borrower and force them to make higher provisions. But a higher provisioning need or lack of capital should not come in the way of more transparency. Some analysts said that disclosure of small defaults by big companies could cause unnecessary volatility in stock prices and would add to confusion. Such excuses are lame and do disservice to investors.
First, this rule only brings parity between bank loans and other debt instruments. On 2 September 2015, Sebi said that listed firms should disclose delay or default in payment of interest or principal on securities such as listed non-convertible debentures, foreign currency convertible bonds, listed non-convertible redeemable preference shares and so on.
Why should a delay in interest payments on bank loans be treated differently? The information asymmetry gives an incentive for troubled companies to borrow from banks rather than the market (the opposite of what Reserve Bank of India is trying to achieve in pushing big firms to increasingly borrow from the bond markets) because they don’t have to share this material information with investors. It is not uncommon for borrowers to delay payments till the 90th day, just before a loan is classified as non-performing.
It is also not uncommon for banks to evergreen loans by providing top-ups and for borrowers to shuffle funds from parent to subsidiaries, all in an effort to keep a loan standard. All this happens behind the scenes and unknown to investors.
For banks themselves, an early warning signal exists because they have the special mention accounts (SMA) classification which categorizes loans that are overdue for up to 30 days, 60 days and so on. Equity investors, too, should get to know when a big borrower misses payments.
The argument that it is not desirable that big companies report on even small defaults doesn’t hold water. The bigger the company, the more resources it has to ensure that loan repayments aren’t missed. Even if a company misses an instalment owing to a so-called technical reason, and makes the payment the next day, it can surely bring that to the notice of exchanges. Investors would reward or punish companies suitably judging the materiality of information themselves. Past track record not being an indicator of future performance applies equally to stock prices or company’s cash flows/loan repayments.
Disclosures of default will also allow the market to correctly discount that information in the share price of a company. The true price (after absorbing the information on defaults) becomes important for banks when they convert debt into equity. In some instances of strategic debt restructuring, the proposed conversion price (decided according to Reserve Bank norms of 10-day average price prior to the day of invoking restructuring) is way higher than current market prices, which incorporate more information. Banks are thus left holding mark-to-market losses.
In the final analysis, this disclosure will act as a preventive measure for the bad loan build-up. When defaults are flagged early, the chances of them snowballing into a major non-performing asset crisis down the road become less. No one likes to be tagged a defaulter, even for one day. It will improve credit discipline among borrowers. Companies won’t borrow beyond what is required and will ensure that payments are made on time.
Disclosures in general are better instruments to change behaviour rather imposing penalties or fines because the latter take a lot of time. It is two months now since these norms have been deferred. The Sebi board should set aside objections and announce these norms when it meets on 28 December.
Ravi Krishnan is assistant managing editor, Mint.