Lessons from twin balance sheet syndrome

The Financial Stability Report (FSR) June 2023 of the Reserve Bank of India indicated that the challenges of ‘twin balance sheet syndrome’ (TBS), known to be a strain on bank balance sheets due to high non-performing assets (NPAs) and highly leveraged corporate balance sheets, is fast receding.

The notable feature is the improvement in the performance of banks and the corporate sector that TBS is fast shaping into a ‘twin balance sheet advantage’ (TBA). The lessons learned the hard way from the TBS experience must be kept in view to avoid its pitfalls.

The transition from TBS to TBA is a prolonged struggle for all stakeholders. The corporate sector, banks and the RBI played a critical role in tackling the perils of TBS.

Banks have significantly improved their performance to come out of the toxic loan crisis and from the euphoria of irrational exuberance in lending in good times, notably during 2006-11, some of it turned toxic at a later point in time.

Regulatory measures

Even the corporate sector realised the risks of excessive borrowing and is deleveraging balance sheets. Among key regulatory measures, the RBI introduced the Central Repository of Information on Large Credits (CRILC) to enable banks to share information on large loan accounts of ₹5 core and above in 2014. In order to detect nascent signs of weaknesses in loan accounts, the RBI insisted collection of information on loans overdue up to 90 days known as special mention accounts (SMA).

The RBI having detected divergence in the asset quality data introduced an asset quality review (AQR) in September 2015.

The enactment of the Insolvency and Bankruptcy Code (IBC) – 2016 and the formation of the Insolvency and Bankruptcy Board of India (IBBI) helped hasten problem loan resolution.

After experiencing the collateral damage caused by TBS, banks will have to take a cue and improve credit risk management systems to avoid its recurrence. Now that the banks are on a stronger footing, and adequate regulatory controls are already working, banks will have to focus on improving the quality of credit origination, monitoring, and control of credit.

The weaknesses that led to TBS should be identified and addressed well. The risk governance and all three lines of defence in risk management (SMA-0, SMA-1 and SMA-2) should be well equipped to ring-fence the banks against credit risk. The internal credit rating system needs to be more robust and red flags prescribed by the RBI should be followed up to detect incipient sickness in units. The development of a strong talent pool in managing credit risks should receive priority. Credit risk managers have a critical role as members of the committee of creditors to hasten debt resolution by invoking IBC.

Proportionality in lending to the corporate sector must be maintained with the right kind of credit assessment. Articulating the right terms of sanction of loans, risk-based pricing, and repayment schedule should be aligned with the fund flows of the entity. Timely disbursement and end-use verification of loans must be ensured. The corporate sector should adopt responsible borrowing and ensure timely repayment of loans to maintain good credit ratings to bring down the cost of borrowing. They should also dissuade invocation of IBC to avoid litigations. Thus, it is the collective efforts of all stakeholders that can maintain the twin balance sheet advantage on a sustainable basis.

The writer is Adjunct Professor, Institute of Insurance and Risk Management – IIRM, Hyderabad. Views are personal

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