RBI GIVES BANKS SOME SHARP TEETH - BUT WILL THEY BITE?

By Ruma Dubey

Yesterday, rating agency ICRA, an associate company of Moody’s published its report on the banks and their rising NPAs and as expected, it was not good news. The report stated that around 25-30% of restructured assets have already slipped into NPAs and it was increasing its estimate of such slippage to 35-40% from the earlier 30-35%.

This was based on data collected from 26 Public Sector Banks and 15 private banks. In current fiscal, ICRA expects banks Gross NPA to rise to 5.3% to 5.9% v/s 4.4% of FY15. In absolute numbers, gross bad loans could rise to Rs.4.2-4.7 lakh crore by March 2016 v/s Rs.3.1 lakh crore in FY15. The maximum slippages are from infrastructure sector, iron and steel and construction. Things could get really tough for banks as effective April’15, from the earlier requisition of providing 5% for restructured loans, it has gone up to 15%, treating them at par with bad loans.

Thus given this dismal picture, in this background, today’s news from RBI could come as some relief for the banks. It has now given banks the option of becoming a 51% equity owner of the borrowing company when it decides to restructure loans. Based on guidelines on Joint Lenders’ Forum (JLF) and Corrective Action Plan (CAP), RBI has stated that the general principle of restructuring should be that the shareholders bear the first loss rather than the debt holders. With this principle in view and also to ensure more ‘skin in the game’ of promoters, JLF/Corporate Debt Restructuring Cell (CDR) may consider the following options when a loan is restructured:

• Banks that decide to recast a company's debt under "strategic debt restructuring" (SDR) scheme must hold 51% or more of the equity after the debt-for-share conversion.
• Lenders can now convert debt to equity within 30 days of the review of the company's account.
• Lenders who acquire shares of a listed company under a restructuring will be exempted from making an open offer.
• The JLF must approve the SDR conversion package within 90 days from the date of deciding to undertake SDR
• Henceforth, banks should include necessary covenants in all loan agreements, including restructuring, supported by necessary approvals/authorisations (including special resolution by the shareholders) from the borrower company, as required under extant laws/regulations, to enable invocation of SDR in applicable cases;
• JLF and lenders should divest their holdings in the equity of the company as soon as possible. On divestment of banks’ holding in favour of a ‘new promoter’, the asset classification of the account may be upgraded to ‘Standard’. However, the quantum of provision held by the bank against the said account as on the date of divestment, which shall not be less than what was held as at the ‘reference date’, shall not be reversed.
• The ‘new promoter’ would in no way be connected with the existing promoter group;
• The new promoters should have acquired at least 51% of the paid up equity capital of the borrower company. If the new promoter is a non-resident, and in sectors where the ceiling on foreign investment is less than 51%, the new promoter should own at least 26% of the paid up equity capital or up to applicable foreign investment limit, whichever is higher.

This is a very good move for banks as it gives them one more chance to recover their money. Even now, banks have the authority to convert outstanding debt into equity but the problem is that not all banks and Corporate Debt Restructuring (CDR) deals put this clause in while lending. But now, starting today, this has changed. Suppose a company, even after restructuring, has an unpaid loan of Rs.100 crore, it automatically leads to a breach of agreed covenants and within a month, the banks will decide whether they need to take majority control or not. If banks can sense that no money would be forthcoming, they can serve a notice to the company, informing them the period within which they will gain majority control.

This means irrespective of the amount of loan outstanding, be it Rs.50 crore or Rs.500 crore, or the equity stake held by the promoters – be it 20% or 74%, this SDR rule will kick in. Thus in case of companies where promoters have pledged all their shares to the hilt, even there stocks will be issued to raise stake of the lenders to 51%.

The aim of this SDR here is not about banks gaining control over defaulting companies but to give these companies another chance, over and above the CDR. The banks aim to find a new promoter who will breathe in new life, like the way it happened in Tech Mahindra. And naturally, a new promoter will come in only when he/she is offered a majority stake.

Yes, this is a great move. It will bring to book willful defaulters and habitual defaulters. But what we wonder is whether banks will show the gumption to take control? Even now, under existing provisions of SARFESAI act, banks could takeover companies but have we read of a single instance of that happening? Banks have not been able to declare Vijay Mallya as a willful defaulter, not been able to take control there; so will these SDR rules ever be used effectively by the banks, especially against big companies?

Also one wonders, in case of defaults causes due to cost overruns on account of delay in clearances and other regulatory overhang, what will the banks do? In such cases too, will the banks swoop in and take control?

Well, the intent and plan is excellent. Let’s see if banks finally start showing that they have sharp teeth and that they can bite too.