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Should banks become AMCs? 
(Mon, 15 Jun Pre-Open) 
 
A few days ago in the 5 Minute WrapUp we had shared our views on the Reserve Bank of India's (RBI) new debt restructuring norms. It allowed banks to acquire 51% stake in firms which are unable to repay loans that have been restructured. What are the pros and cons of this move? If you own PSU banking stocks in particular, should you fell heartened? To answer this question, let us take a close look at what these new rules are.

The new scheme is called 'Strategic Debt Restructuring' (SDR). It allows banks to collectively acquire 51% (or more) stake in those firms that have defaulted even after restructuring the loans they have taken. Banks can convert the outstanding debt into equity within 30 days of reviewing the company's accounts. While doing so, banks are exempted from making open offers. The RBI has advised banks to sell the stake 'as soon as possible' to a new promoter and ensure that he/she is in no way related to the borrower. The entire process must be completed within 90 days.

One can understand what the RBI is trying to do here. The SDR will help banks clean up their books fast while still holding on to the asset. They will also be freed from making more provisions for the same. Also, the equity stake is not required to be marked-to-market. The RBI believes this will help to stem the tide of slippages in restructured assets. As per an article in the Business Standard which quoted a report by ICRA, gross NPAs of the Indian banks increased to Rs 3.1 trillion. What's worse is that 25-30% of slippages are from restructured loans. No wonder the RBI has gotten aggressive about this.

Basically, the RBI is allowing promoters one chance to pay back via the restructuring route. If not, they risks losing their companies due to SDR. Selling off such sick firms will also help banks increase their lending to the deserving ones thus providing a boost to the economy.

All this is well and good. But will it work? That is the million dollar question! Willful defaulters knows how to game the system. They have doing so for years. They may trap banks in endless legal procedures.

Also, banks know nothing about running other businesses. This is why the RBI has asked them to sell the majority stake 'as soon as possible'. But this assumes that they will be able to quickly find buyers for the same. This is far from guaranteed. What if they don't? For how long will they own majority stakes in such firms?

Another serious issue is about valuations. The new rules state the debt-to-equity conversion should be done at either market value or the break-up value, whichever is lower. The break-up value is to be calculated from the last audited balance sheet. This means that a buyer can possibly scoop up a defaulting firm for peanuts. It is not clear how this will be beneficial for banks and its shareholders.

Lastly, if a bank believes that it can easily acquire a firm in case of default, then would they really tighten their lending standards? After all, poor credit appraisal is one of the reasons why the NPA problem is so serious. We believe there's a chance the SDR may perversely end up becoming a disincentive to banks when it comes to making sensible business loans.

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