RBI's debt recast scheme: An unsustainable moral hazard

India's too-big-to-fail appear to have prevailed yet again. The Reserve Bank after a determined effort to clean up the banking system of disguised defaulters, has been forced to recognize the need to bail out large units in a resource-poor and underemployed country. On Monday it announced what it called a Scheme for Sustainable Structuring of Stressed Assets. Under this scheme banks will be allowed to restructure loans of large borrowers whose earnings or EBIDTA is patently inadequate to service their debt. First banks will calculate the amount of loans a company can service with its current earnings. They will carve out the balance portion as "unsustainable" debt and convert them into convertible preference shares or convertible debentures or equity. Banks have to provide for the loss of interest from their profit, while promoters get away with lower interest payments. Their only penalty is they lose a bit of their company's stake to the banks. Conversely the only gain for the banks is if, at a distant date the companies become profitable and they are able to sell their shares and make good their past losses. Yes there are some safeguards: the projects for which the loans have been taken must be complete and running and generating income. Not more than half the debt can be considered unsustainable. Banks should obtain promoters' personal guarantee at least for the sustainable part of the debt. And finally, a committee of eminent persons appointed by the Indian Banks' Association will ensure if due process has been followed in all cases. One accepts the bankers' plea that India can't afford to junk Rs 8 lakh crore of assets; also that allowing one large company to die will mean killing a whole ecosystem of workers, their families, subsidiary companies, suppliers, their employees and families. But that said, it is difficult to ignore the moral hazards thrown up by the scheme: Firstly, there is really no pain for a profligate promoter who may have wantonly gold-plated his capex plan. In fact it is precisely such promoters who may benefit. Secondly where does one draw the line? Even if bankers start with companies which are genuine victims of a global downturn, what is to prevent many large companies from claiming that their debt is unsustainable and demanding a reset from banks. There may be some loss of equity, but knowing Indian promoters most will find a way of diluting the bankers' equity. Thirdly, how will bankers encash their way out of unlisted companies, except by selling it to the promoters themselves? At least one large steel-oil-power conglomerate must be literally laughing its way to the banks. Fourthly, banks appeared to be close to forcing some promoters to sell off their non-core assets. Now suddenly, bankers have lost some of their power to arm twist. Promoters will demand of bankers their right to convert debt into equity instead of the other way round. Fifthly, the rules require banks to demand personal guarantees from promoters for the sustainable part of their loans. What prevented the RBI from requiring promoters to give personal guarantees for the unsustainable portion of their loans too. Is it a tall price to pay for squandering depositors' money? As of now at least some promoters get to gold plate their capex, renege on their loans, not pay the interest and yet keep their yachts and jets. One hopes bankers will continue with their current zest to make promoters sell of their healthy and non core assets before giving wiritng down their debt. One also hopes the overseeing committee of eminent persons will see through at least some of the habitual defaulters and foil their plans to get away with the loot.