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Business News/ Opinion / How to deal with the corporate debt problem

How to deal with the corporate debt problem

Policymakers must address the corporate governance problems in banks

Illustration: Shyamal Banerjee/MintPremium
Illustration: Shyamal Banerjee/Mint

The head of the biggest Indian bank has done well to use a military metaphor to describe her most urgent task. State Bank of India head Arundhati Bhattacharya told this newspaper that Indian lenders have to go into the war against bad loans with a variety of weapons rather than bare hands. The imagery Bhattacharya has used shows the scale of the task ahead. Weak banks are perhaps the biggest potential risk to economic stability right now.

The past few months have thankfully seen the system move away from denial. A whole range of ideas have been floated for public discussion—from a national bad bank to a distressed asset fund to massive capital infusion to the financial restructuring of firms that have excess leverage. The Reserve Bank of India has already allowed banks to take control of defaulting companies by converting loans into equity.

India should learn the right lessons from how other countries have tackled financial crises. In a speech he gave last week, International Monetary Fund first deputy managing director David Lipton delineated three major lessons from the international experience with high corporate debt, and the resultant stress for the banks. Lipton was speaking in the context of the Chinese corporate debt mountain, but Indian policymakers would do well to heed his advice as well.

First, governments have to act quickly and effectively if the problem is not to worsen. India has let its bad loans problem fester for too long, with the Indian central bank providing regulatory forbearance while the lenders themselves have been hiding the extent of the problems through tricks such as evergreening of loans. It is to Raghuram Rajan’s credit that he has forced banks to come to terms with their asset quality problems.

Second, the problem of bad loans has to be dealt with on both fronts—the lenders and borrowers. Too many of the current solutions focus on moving bad assets off banks’ balance sheets. The underlying problem is that companies do not have cash flows that are adequate to service their debt. Their capital structure needs to be altered as well, or the problem will crop up again.

This is broadly parallel to what the Indian government has done in successive attempts to deal with the debt of state electricity utilities. The stock problem (existing debt) is addressed without a matching focus on the underlying flow problem (cash flows of the state electricity boards). This is generally true of all corporate debt challenges.

Three, policymakers must address the corporate governance problems in banks and companies rather than just focus on the task of repairing balance sheets. This is of critical importance. The Narendra Modi government must try to change the way Indian banks and Indian companies are governed—as well as break the umbilical link between politicians and bankers. It will be an important battle in the larger war against crony capitalism. The Banks Board Bureau is an important innovation in this context, but corporate boards have also to be pulled up for allowing company promoters to destroy shareholder value.

These three general principles —decisive action, capital restructuring and governance reforms—can prove to be useful guidelines as the banking mess is sorted out.

There is a fourth issue that will also need to be dealt with in India. Bankers will need protective cover as they begin to strike deals either with company managements, the national bad bank or the asset reconstruction companies. Finance minister Arun Jaitley has done well to reassure bankers that the government will back them. But there is no denying the fact that the fear of the courts, the investigative agencies and public opinion in general worries bankers.

The government needs to educate them about the fact that getting less than 100 paise on every rupee is not an act of banker corruption. That is not an easy task, unfortunately.

Will restructuring capital help in addressing India’s corporate debt challenge? Tell us at

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Updated: 14 Jun 2016, 02:59 AM IST
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