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Beware the third of October: Litmus test awaits 'Swachh Banks' mission

Most bankers, rating agencies, brokerages and companies are unsure about the outcome of SEBI’s seismic rule requiring all companies to declare their loan defaults to banks within one working day.

September 18, 2017 / 09:44 AM IST

Latha Venkatesh

It is surprising there is so little debate and worry about October 3. What is important about that date? It's the day when market regulator SEBI’s seismic rule kicks in requiring all companies to declare their loan defaults to banks within one working day (The rule officially kicks in on October 1, but October 1 and 2 are trading holidays).

At the outset, it must be stated that this rule itself is a welcome revolution, a much-needed cleansing of the banking system and its nexus with corporate India. For too long now, there has been huge opacity in terms of how many companies are paying back their loans leading to the current accumulation of Non-performing assets (NPAs) or non- performing loans with banks. Had this rule been put in the books in 2010 or 2012, such an accumulation of NPAs may not have come to pass.

Also, there are those who believe that thanks to the AQR or the asset quality review by Reserve Bank of India in 2015, most of the big NPAs or defaults are well and widely known and hence starting October, nothing new is going to be revealed that can rattle the stock markets.

There are also others who believe that like the GST, there will be temporary disruptions, but things will settle down as those who default by a few days pay back and the fresh disclosure reassures markets.


The truth is most bankers, rating agencies, brokerages and companies are unsure how this will play out and some are terribly worried.

Here’s why.

Bankers say non-payment of interest to banks even by a day could lead rating agencies to immediately downgrade the bank facilities of these companies to "D". Bank loans to companies rated "D" in turn will have to be supported with higher risk capital. Given that banks are already facing the prospect of large need for capital to meet NPA and bankruptcy cases, this fresh onslaught can stretch them.

What is worse, once a company is rated "D", banks may even be unwilling to give them fresh loans since even these will attract higher risk capital. Hence, what may be a few days’ default for some innocuous reason may lead to stoppage of credit and hence stoppage of production for a longish period.

The SEBI rule comes at a particularly inopportune time when liquidity in the system is already very tight because of the Goods & Services Tax or the GST. Exporters haven’t got their Integrated GST (IGST) credits from the government because the network is still not fully functional. Further, companies have not got their input tax credit either which means a larger part of their working capital is locked up with the government as taxes.

With the cash situation already tight, the chances of hundreds even  thousands of companies defaulting by a few days is very likely. And if their bank facilities are immediately rated "D" by the rating agencies, and the banks therefore refuse to lend additional credit, many companies can go out of business temporarily. Like under demonetisation and GST, some may not have the buffer to stay put and can go out of business permanently.

It is possible things may not play out so badly. Companies may borrow from their group companies and associates and avoid default, knowing the consequences. In many cases, it may only be a case of disciplining cash flows to pay on the 29th day, unlike the current processes which are designed to pay on the 89th day.

Also, some experts say most of the loans in India are given by banks on a cash credit basis, and the danger of default in these cases is low since companies rarely borrow up to their limit.

Some also  argue that most of the stressed companies are already in SMA1 or SMA2 category. (SMA is  special mention category; SMA1 comprises loans where interest has not been paid within 30 days, and SMA2 are those where interest is over due by over 60 days). Banks are already aware  of these.

But some bankers say being aware of a stressed loan is not the same as having to provide additional risk capital for them. Starting October, they say, most banks can become even more averse to lending, and the aversion will start even as the “busy” season for business starts. In addition, companies barely recovering from demonetisation and GST may be unable to survive in the face of the fresh squeeze on capital.

All this may not happen, but perhaps the regulators – both SEBI and RBI – need to call bankers and rating agencies and ponder over how the rule may be actually implemented without killing the spirit of the rule or the businesses.
Latha Venkatesh
first published: Sep 18, 2017 08:08 am

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