Andy Mukherjee is a Bloomberg Gadfly columnist covering industrial companies and financial services. He previously was a columnist for Reuters Breakingviews. He has also worked for the Straits Times, ET NOW and Bloomberg News.

When lenders allow 11 percent of their advances to sink into distress, they should be punished for playing footloose with other people's money. Instead, India is rewarding bankers by letting them pose as private-equity investors. Their undeserved new hat is a lousy fit.

A consortium of creditors, led by State Bank of India, the country's largest,  has decided to exercise a ``strategic debt restructuring'' option on IVRCL, the unprofitable road builder informed the stock exchange on Tuesday. The company had $1.5 billion in debt as of March, and little hope of repaying it.

Rough Road
Source: Bloomberg

The restructuring will see the banks convert their loans into equity, after which they will have 18 months to find a buyer for their stake. Fail to do so, and the banks will have to recognize the loan as bad and provide for the loss.

All the best to the bankers if they think they will have better luck as shareholders than they did as creditors to IVRCL, Gammon India, Monnet Ispat and a clutch of other steel and construction companies. 

India's central bank allowed banks to swap debt for controlling equity stakes six months ago, and already more than $9 billion has quietly slipped into this extend-and-pretend wormhole, according to brokerage Religare. Strategic restructuring is helping banks report only $53 billion in non-performing assets, according to ICRA, a rating company, which estimates their total troubled exposure may be more than twice as large, at $113.9 billion. 

From the perspective of minority shareholders in these companies, the bailouts are welcome. IVRCL shares jumped 20 percent on Monday on the whiff of an impending debt recast. Relief rallies have become a standard event around restructuring announcements: 

Stocks Buzz
Banks swapping debt for equity in troubled Indian companies brings short-term relief
Source: Bloomberg

Investors who would have lost their entire capital in a bankruptcy, for which India still doesn't have a law, will now at least get something back.

It may be a different story for shareholders in India's state-controlled banks. While the debt-to-equity swap removes the threat of an immediate loss, the banks will still have to turn around these floundering enterprises, and are hardly teeming with talent in handling corporate distress. In the meantime, they have given up their status as creditors, placing themselves at the bottom of the pecking order in the event the company goes into liquidation anyway.

A further risk is that the banks now have an incentive to carry on lending to the companies to keep them in business. If the troubled borrowers fail to lift their operating profit, any new loans would also become non-performing assets. That's an especially big danger in the metals industry, which is facing a global glut. Already, about 5 percent of Indian state-run banks' total loans are to iron and steel companies.

The debt-for-equity deals look to be encouraging state-run banks to keep zombie producers in business -- a policy that can only backfire in the end. Since most banks can't raise funds from the markets, they are jumping at the chance to make the consequences of their bad lending decisions disappear for a while. For the central bank, letting lenders wear the hat of controlling shareholders is a bad idea.  Trust them to return 18 months later to the authorities begging for capital -- hat in hand.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

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Andy Mukherjee in Singapore at

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