Yet another blow for Indian banks?

Thu, 26 Jul Pre-Open

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The slowing economy has taken a toll on a number of companies in India. Demand for their products and services have reduced. Elevated interest costs are also eating into margins. Thus, many companies are approaching bankers in order to restructure their debt and ease their burdens. The restructuring of advances serves a useful social purpose as it protects the productive assets of the economy. It can help inject a lifeline into companies that are on their last breath.

But, for banks, especially state run ones (PSUs), it is a separate story. The cumulative 'standard restructured' advances rose from Rs 604 bn as on March 2009 to over Rs 1 trillion as on March 2011, and currently stands at elevated levels. PSU banks have so far led the party on the restructuring front. But, the new corporate debt recast (CDR) norms issued by the Reserve Bank of India (RBI) last week will have a significant impact on their profitability.

In order to prudently recognise the inherent risks in existing assets classified as standard on restructuring, an RBI working group has called for additional provisioning on these assets. It states that the provision requirement on such existing accounts should be increased from the present 2% to 5% in a phased manner over a two-year period. Thus provision will be increased to 3.5% in the first year and 5% in the second year. However, in cases of new restructuring of standard asset, the working group recommends that a 5% provision should be made with immediate effect. If this move is implemented, state run banks will see a strain in profits, while private sector banks will be relatively sheltered.

The working group also has a few more recommendations with regards to conversion of debt into equity/preference shares, with such a classification only to be made as a last resort. The group recommended that RBI could consider a higher amount of promoters' sacrifice in cases of restructuring of large exposures under corporate debt restructuring. Thus promoters will need to be more committed by compulsorily providing personal guarantee in all cases of restructuring. Until now, such guarantees were exempted when the restructuring was necessitated on account of external factors pertaining to the economy and industry. Also, corporate guarantee cannot be classified as personal guarantee. Even if there is a short term impact on profits, we believe that these classifications are beneficial as only those accounts which really need to be restructured will be reclassified. Plus, with promoters giving a higher commitment, they will be more dedicated to the cause, and the risk of these accounts turning NPA may reduce.