The global economic crisis during 2007-12 is largely blamed on the systemic failure of multinational financial giants. As these global financial powerhouses defaulted on their liabilities, the shockwaves rippled across nations, economies, and societies. As a preventive measure after the 2008 crisis, the elite G-20 pressed for the need to identify Systemically Important Financial Institutions (SIFIs) all around the world. The idea was to increase collaboration within the global community to safeguard the global financial ecosystem in case one or more SIFIs fail in the future. The financial stability board came out with its global list of SIFIs in 2011.
Even though SIFIs are regulated by local regulations, the broad idea is to make these institutions comply with the higher capital requirements and follow stricter risk management procedures while eligible market participants are to report all transaction data to the local regulators on near real time basis. These measures are aimed at enhancing standardization, transparency and lower credit risk in Financial Institutions in India (both domestic and foreign) are no different. However, the primary cause for their crunch was deduced to be the impact of a larger global issue. As a result, India was an active participant of the G20 pact in 2009 and also ensured implementation of the agreed intents (including that of identifying SIFIs and strengthening regulations for these).
However, while busy in leashing the financial institutions a.k.a. banks, regulators have summarily ignored the non-financial parties who have equal capacity to bring a similar crisis in the markets. These SINFIs (Systemically Important Non-Financial Institutions) do not come under the direct scanner and purview of financial regulators such as the Commodity Future Trading Commission in the US or the Reserve Bank of India here. In India, many of these have borrowed from multiple banks especially from public sector. According to a report by India Ratings and Research, Indian banks would need an additional Rs 1 lakh crore to manage their exposure to highly leveraged and stressed companies. Out of this, Rs 93,000 crore is needed by public sector banks (PSBs).
The Winsome Group, for example, willfully defaulted on Rs. 7,000 Cr. There were doubts of foul play as the evidence suggests that Winsome promoters duped the banks and diverted the funds abroad. The loan exposure was led by Punjab National Bank (Rs. 1,800 Cr), with 14 banks being part of the consortium. Foreign clients that owed Winsome more than $1bn seem to be leading to a conspiracy by the promoters themselves, and only $1mn could be recovered from them in 10 months of banks declaring the loan as a non performing asset (NPA).
Similarly, Kingfisher saga is afresh where Rs. 7,000 Cr of loan was sourced from Indian banks and only Rs. 6 Cr seems retrievable. This impacted up to 14 banks with State Bank of India leading the These two are the largest declared NPAs by Indian Banks and have set the alarm bells ringing. But the potential and magnitude of negative surprises that may emanate from the corporate world in India and destabilize the financial environment is much higher. With small and medium businesses added to the tally, the gross NPAs of Indian banks accumulate up to Rs 2.28 lakh Cr at the end of Q1.
As banks write off these NPAs, their ability to service their retail and genuine loan customers dwindles. This has an indirect but equally destructive impact on the financial and economic situation.
Restructuring is a much misused mechanism of bringing down the NPAs which just procrastinates dealing with the issue. Interestingly, it is the public sector banks where the NPAs have gone up, while the private sector banks have been cleaning up their books. It is because the formers seem keener to restructure their loans and avoid calling it an asset bad.Of all the G20 countries, Indian regulators (e.g. RBI) are the first to take a step in the right direction.
To ease the recovery of assets by banks from companies that are near-bankrupts, RBI has issued new norms facilitating banks to be able to do “Strategic Debt Conversion (SDR)” and force stringent conditions on stressed loans when renegotiating. If the conditions are not catered to, banks can convert these outstanding loans into a majority equity stake and push the defaulting, non performing promoters out. Ability to convert loan to equity stake will now be a pre-condition for all restructuring of deals. The decision on conversion has to be taken within 30 days of re-structuring milestone not being met. The assets thus converted can then have new promoters instated or can be sold to PE firms to manage and turn around or be liquidated with reduced legal hassles. But the road to recovery of loans would be there and much better than the current state with impending defaults and abysmally dismal recovery rates.
However, above move is still more reactive in nature wherein regulators are looking to recover from already disbursed bad loans. This still does not prevent a corporate from sourcing debt from multiple.
Financial Institutions and a bank from accumulating potential NPAs. Whatever the mechanism, recovery process is always cumbersome, takes time and is not 100% effective. Hence RBI’s move has been touted as “too little, too late” by some as the entire equity of the stressed companies is estimated to be only one eighth of the outstanding debts, limiting the recovery through this conversion route.
Nevertheless, regulators need to find a long term solution to it. A more preventive measure would be for the RBI to institute a process to analyze the aggregated loan data from various banks and identify the Systemically Important Corporates or Non-Financial Institutions (SINFIs). SINFIs should be identified across key sectors such as infrastructure, airlines, telecom etc. that already account for 20% of bank loan books in India. Banks can then be instructed not to disburse any more loans to a SINFI unless it can prove its capacity to service its existing loans and more. Also, provisions like SDR can be placed at the very onset of a new loan agreement. SINFIs can also be regulated more closely by the respective sector’s regulators and be guided to put more transparent processes in place so as to avoid the misuse of those loans for supporting the lifestyles or illegal funds transfers etc. by its promoters.
A corporate identified as SINFI (by the virtue of its loans, its liquidity, and banking sector’s fragility to survive if it defaults) is not a medal it would want to be bestowed with or be answerable to its shareholders for. Corporates may take proactive measures to avoid the tag and be more disciplined and transparent.
Mahima Gupta is Senior Manager, Business Consulting, Sapient Global Markets
