Illustration: Jayachandran/Mint
Illustration: Jayachandran/Mint

The unresolved problem of twin balance sheet

Even in a favourable economic condition, revival may be difficult for some companies

The Reserve Bank of India (RBI) is revising rules in order to help banks deal with higher levels of non-performing assets (NPAs) and is tightening norms so that a similar build-up is avoided in the future. Last week, the banking regulator released guidelines to contain concentration of loans in a single company and a group of connected companies. According to the new rules, banks will have to limit their exposure in an individual company at 20% of their tier 1 capital compared with 15% of the total capital currently. For a group of connected companies, the exposure has to be limited at 25% of the core capital from the present norm of 40% of total capital. These new norms will be applicable from 1 April 2019.

Earlier this year, the RBI announced measures that will make lending to large borrowers expensive for banks beyond a specified limit. The idea here is to push large borrowers to the bond market and avoid concentration of loans in the banking sector. It has also announced several measures to boost activity in the corporate bond market. Further, the central bank has empowered lenders to deal with non-performing loans. For instance, banks can convert a part of the debt into equity to take controlling stake in a stressed company under certain conditions and sell it to a new promoter. As noted earlier in this space, the current bad loan problem has become a difficult learning experience for the banking regulator where it has to continuously gauge the progress and make changes in the rule book so that banks are able to move out of the current problem.

While on the one hand banks, especially in the public sector, are struggling to cope with the pile of bad loans, highly leveraged companies on the other hand are finding it difficult to repay. For example, a recent report by India Ratings and Research showed that 111 of the top 500 corporate borrowers with Rs7.4 trillion worth of debt are unlikely to generate return on capital employed that is higher than average cost of capital. Revival may be difficult in a number of stressed companies with weak asset quality. This is one of the reasons why companies are selling assets to reduce debt on their balance sheets.

A Mint series on corporate debt published in November showed that Indian companies are selling assets at the fastest pace since the beginning of economic reforms. According to the data, the Indian corporate sector has announced assets sales worth over $40 billion in 2016. The figure is much higher than the previous high of $27.96 billion recorded in 2007.

However, there is a big qualitative difference. The previous high was at the peak of the global economic boom when companies were in expansion mode and were willing to pay even higher prices for acquiring assets. This was also the time of a credit boom and build-up of excess debt. But the cycle turned with the global financial crisis of 2008. The inability of the government to take quick decisions in the early part of the current decade, which led to stalling of projects and liberal lending standards prevalent in the Indian banking sector, also resulted in accumulation of NPAs in the system.

It’s not that only big companies which usually grab the headlines are struggling to repay. The corporate debt series quoted above, which also analysed non-financial firms in the BSE-500 index, showed that the capacity to service debt is at a 10-year low and the problem in the bottom quartile is more acute. Ranked by market value, average debt in companies in the bottom quartile is about 2.3 times their market capitalization. Clearly, these companies will find it extremely difficult to come out of such a situation even in a relatively favourable macroeconomic environment. It is likely that the asset sale will accelerate in the medium term and banks will have to take a significant hit.

However, the recovery process may get delayed because of the ongoing currency exchange drive of the government. The consensus view on the street is that economic activity will be hit in the short run because of currency shortage, which could make repayment of loans difficult for a number of companies. Further, the RBI decided to squeeze excess liquidity from the system through cash reserve ratio (CRR) on which banks don’t earn interest. This will affect profitability as banks will have to pay interest on deposits coming into the system because of currency swap but will not earn anything on it. On Friday, the ceiling on issuance of securities under the market stabilization scheme was revised, which means CRR could be
rolled back.

Even though India’s corporate debt as a proportion of gross domestic product is lower than some of the major economies in the world, the twin balance sheet problem is likely to remain an obstacle in the revival of investment and growth.

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