Soon, more leeway for firms to convert loans into equity

The RBI will give banks more leeway to convert loans into equity when they restructure loans. In May last year, the central bank had limited the extent of conversion of debt into equity to about 10 per cent of the shares of the company because of some concerns over the prices at which such conversion was happening.

Banks have argued that this (10 per cent cap) also limits the upside they can get if the project turns around and that over the last mile if they can make some concessions on the debt but get substantial equity in return, they could get some possible upside.

“We have looked at this argument a little more sympathetically,” said Governor Raghuram Rajan.

Precisely, how much leeway banks will get to convert loans into equity will be announced shortly by the RBI, he added.

“The key issue is can we agree on a price range that will make the RBI feel comfortable that it is protecting the banks from over paying and at the same time gives SEBI the comfort that it is protecting the minority investors from getting too low a price for the equity that is being transferred. That is where the discussion is,” said the Governor.

Pointing out that this (pricing) was part of the reason that some of the loan conversion into equity was stopped, Rajan said “in the sense that perhaps you could not have full faith that this will not be used to mask bad loans.”

“The counter argument is that if you distrust the banks totally in the restructuring process, then borrowers are not going to get restructuring. Many of these projects (especially infrastructure projects) are in deep trouble and will need new infusions of funds.

“And unless the capital structures are remedied there will be no infusion of funds, which are needed to complete the project. So, how do you get new infusion of funds? You will have to restructure the capital structure somewhat,” explained the Governor.

So, some flexibility has to be allowed with a bunch of safeguards. So, that is what the RBI and SEBI are trying to do.

“The alternative today when you can’t take the equity is to write off the debt and hope that the fellow (borrower) will be nice to you and compensate you later on or that you exercise the right of compensation.

“This way the right of compensation is embedded in the equity. So, if the project succeeds you got a big chunk of equity which comes as upside. So, depending on how you look, this can be seen as a reasonable thing or if you look at it the blackest way possible it can be seen, what you just said, as a backdoor way of essentially writing off bank assets,” said Rajan.

So, the RBI and SEBI are trying to work out what the appropriate loan conversion price should be.

Meanwhile, the RBI also plans to give concessions for restructuring infrastructure and core industry projects under the so-called 5/25 scheme.

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