Mumbai/New Delhi: Indian banks are staring at the prospect of restructuring loans to loss-making state electricity boards in order to stave off defaults.

State-run Punjab National Bank (PNB) gave fresh long-term loans to pay off short-term debt to help a financially troubled distributor in the September quarter, its chairman K.R. Kamath told Reuters, kicking off what could become a trend.

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“Some of the state electricity boards are asking for loan restructuring. We’re seeing how that can be worked," M. Narendra, chairman and managing director of Indian Overseas Bank, which has lent more than 91 billion rupees ($1.8 billion) to the sector, told a media briefing on Tuesday.

India’s top two lenders, State Bank of India (SBI) and ICICI Bank, have the highest exposure to the power sector, with more than Rs30,000 crore of loans each.

“I really expect banks to come to us in the March quarter when the stress goes beyond manageable proportions," said an executive at a state lender on assignment to the Corporate Debt Restructuring Cell, a voluntary body that works with banks and borrowers to restructure problem loans.

The executive declined to be identified given the sensitivity of the matter.

“Right now banks are trying to resolve cases at individual level. They are shell-shocked now. The writing was on the wall for a long time but they didn’t see it," he added.

Ratings agency CRISIL last month raised concerns about the health of power sector lenders including Power Finance Corp and Rural Electrification Corp as well as banks, pegging potential risk at Rs56,000 crore unless the government implements reforms in the sector.

Power Shortage

Losses at state electricity distributors, which depend on state support and borrowings from financial institutions to meet revenue shortfalls, doubled in the two years from April 2008 to $12.9 billion, according to a Power Finance Corp report.

Banks and others say India needs to raise power tariffs, but that is difficult in a country where farmers, a crucial voting bloc, receive power for free or at a steep discount.

Much-needed generating capacity in a country that suffers frequent blackouts and a peak power deficit of 12%, meanwhile, has been delayed by difficulties in securing land and coal, deterring banks from lending to the sector.

Distributors on average raised prices by 12% over the two years through March 2010 even as costs rose 21%, state-run Power Finance Corp said in its report.

Over the past decade, India has implemented reforms that separate power generation, transmission and distribution, thereby ensuring distribution losses do not hurt growth in other segments of the industry.

It has also invested in electric meters and other infrastructure, but still has a long way to check transmission and commercial losses of over 27% in the year ended March 2010. Early in the previous decade, losses were 40-45%.

With state governments reluctant to lend more to close the revenue gap for distributors, utilities have stepped up bank borrowing at a time when interest rates have risen steadily.

“The key problem is inefficiency. Raising tariff will not solve the problem," said Kuljit Singh, a partner in the infrastructure practice at Ernst & Young. Such losses cannot be curbed without shifting distribution to private firms, he said.

For now, private sector participation in power distribution is minimal and limited to a few cities.

New Delhi recently set up a panel to recommend ways to improve the financial condition of power distributors.

Keeping Wary Eye

Punjab National Bank, the No.2 state lender, restructured loans worth 40 billion rupees in the September quarter, nearly half of which was to the electricity board in Tamil Nadu state, according to a Standard Chartered report.

The bank’s restructured loans now account for 7.8% of its total gross loans, highest in the Indian industry, according to the report.

Private sector banks ICICI, Axis Bank and IndusInd Bank played down any danger and said their loans to the power sector were performing and safe.

“We have had no slippages, we are not overly worried," ICICI Chief Executive Chanda Kochhar told reporters this week.

Several banks, however, have said they will remain cautious.

J.P. Dua, chairman and managing director of Allahabad Bank, which has loans to electricity boards including in Uttar Pradesh, West Bengal, and Delhi, does not expect defaults or restructurings but is steering clear of the sector for now.

“Last six months, we have not sanctioned a single loan to power sector. We don’t want to get into it till things get sorted out like coal issues, land clearances and all the other issues," Dua told investors on a call on Wednesday.