Debt restructuring: Focus on long-term relief

SA Raghu | Updated on August 20, 2020

Debt relief: Several factors to consider   -  istock.com/Andrii Yalanskyi

NPA pile-up is more due to cash-flow issues than projects per se going bad. The RBI panel must provide relief for banks and borrowers

The demands for debt restructuring were inevitable as the lockdowns dealt massive blows to businesses and their revenues. Although debt restructuring guidelines have been around a while, they have not worked — according to RBI data, around ₹30 trillion of debt cumulatively was restructured during the past 10 years, yet both financial stress and NPAs have only been rising. Banks had used the schemes mostly to postpone the downgradation of loans, with resolution plans doing little more than shifting repayment schedules around. The guidelines themselves were overtly focussed on incentives and disincentives, with little to ensure the quality of resolution. That is perhaps why this time around, the RBI thought it fit to let an expert committee do the job, and importantly, vet resolution plans for large cases. But debt restructuring as relief itself raises several issues.

For one, with version 2.0 intended only for Covid-stressed borrowers, is the mandate to provide short-term relief or address the longer term? The RBI’s terms of reference vaguely refer to the long-term viability of firms, but perhaps we will know for sure only when the committee’s report arrives. This is important because unlike normal economic distress, the pandemic is radically changing business models. It would be simplistic to assume the future as an extension of the past, because the very viability of many businesses is being called to question. Borrowers will undoubtedly be revaluating on their part, but banks need to be more concerned about the long-term prospects of their portfolio rather than only saving NPAs.

Hopefully, the committee will go beyond normative prescriptions on debt equity and interest coverage and help banks formulate viable plans. Actually, the banks are in a better place in this regard, as they presumably are privy to huge amounts of borrower data — financials, repayment history, cash flows — which should offer them enough insights into the working of many sectors.

Debt problem overstated

Second, the issue of corporate debt, specifically of excess leverage, seems overstated. If we go by data, businesses seem to be having a profitability issue rather than a debt problem (though stock markets would disagree). The RBI’s own company finance data for over 250,000 non-financial firms for the past eight years show that gearing, on an average, has been less than unity, hardly a frightening number.

Asset turnover ratios and profit margins have been low, pointing to cash-flow inadequacy, not to a debt problem. In fact, Indian private non-financial debt-to-GDP ratio at around 50 per cent is among the lowest in the world. To be sure, NPAs are reckoned at the micro-firm level, where the picture may be different, but overall it appears that debt restructuring is a softer option to address.

Moreover, with our credit system being bank-led, the issue of corporate distress inevitably gets tied up with banks’ health, which means concerns about financial stability lend that extra urgency to the issue of debt restructuring. This has helped create an ambivalent attitude to bank borrowing — borrowers are over-leveraged and cannot borrow more, yet they must invest; banks have over-lent and cannot lend more, but are forced do so to kick-start recovery.

Mismatched financing

Finally, the nexus between corporate debt and bank NPAs is more complex than it looks. The NPA pile of banks is not entirely the outcome of economic distress — it is a motley mix of problems in core sector lending, infrastructure finance and simply, many cases of wilful defaults and frauds. When banks forayed into industrial financing and infrastructure lending, it was a classic case of mismatched capabilities — banks did not have the lending bandwidth while projects had only back-ended cash flows — a clear example of the timing of cash flows being more important than their adequacy (which the conventional interest coverage ratio measures). Clearly, many of these projects could not always pass a 90-day default test for NPAs.

But the new restructuring scheme is about dealing with disruptive economic distress, which cuts across a wide swathe of sectors in the economy and is still playing out in terms of impact. Banks have the equally difficult task of identifying Covid-distressed borrowers and managing competing demands.

Interestingly, individual loans have also been brought into the ambit as personal loans now form a significant proportion of bank credit. But mandating resolution plans to be in place by December 2020 and getting implemented within six months, seems a tall ask. One only hopes it does not meet the fate of previous restructuring schemes and end up saving the banks without providing any long-term relief to borrowers.

The writer is an independent financial consultant

Published on August 20, 2020

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