Rajan Seeks to Deter Indian Defaulters as Fitch Sees Challenges

As India’s central bank rewrites rules to help lenders recover loans from defaulting companies, the local unit of Fitch Ratings Ltd. said the move is fraught with challenges while bankers welcomed the measure.

Under new rules released by the Reserve Bank of India late Monday, lenders will be allowed to convert loans into equity and take a controlling stake in a stressed company under a so-called strategic debt restructuring plan. The banks will also be allowed to bring in management of their choice to make the company profitable.

RBI Governor Raghuram Rajan is seeking ways to clean up lenders’ balance sheets as stressed assets, set to surge to the highest level since 2002, threaten to derail an economic recovery. Four of India’s five biggest banks reported an increase in bad loans for the year ended March as policy makers’ efforts to boost investment and growth have yet to bear fruit.

“In the current scenario, this may be too little and a bit late,” said Deep Narayan Mukherjee, a senior director at Fitch’s India Ratings and Research Pvt. “Even if the lenders take over the entire equity of the stressed companies, on average its value will be only about an eighth of the outstanding debt. So recovery through converting debt into equity may be limited.”

Credit Growth

Prime Minister Narendra Modi is counting on a revival in credit to accelerate growth in Asia’s third-largest economy after the RBI cut its benchmark interest rate three times this year. Lending increased 10.2 percent in the 12 months through May 15, RBI data show, rebounding from February’s 8.88 percent, which was the slowest pace since 1994.

Bankers said the RBI’s new rules may provide them a better chance of recovering debt.

“These rules will be a deterrent for errant companies considering default,” said M.S. Raghavan, chairman and managing director of state-run IDBI Bank Ltd.

Profitability, measured by the return on assets in the banking system, fell to 0.81 percent in the year ended March 2014, the lowest since at least 2007, RBI data show. The increase in stressed assets and slowing loan growth may further erode lenders’ earnings power, according to Fitch.

“This is another avenue for enabling recovery of stressed assets,” said Pradeep Kumar, managing director at State Bank of India, the country’s largest lender by assets. “This strengthens our hands in efforts to recover bad loans.”

The lender is focused on improving the asset quality in coming quarters, Kumar said. State Bank of India narrowed its gross bad-loans ratio to 4.25 percent as of March 31 from 4.9 percent reported in December, exchange filings showed.

Stressed Assets

Stressed assets of Indian lenders will rise to 13 percent of total advances by March 2016, according to Fitch. The ratio was 10.73 percent as of December, the latest central bank data show.

Crisil Ratings, Standard & Poor’s Indian arm, estimates the sum of total soured loans and restructured advances that are likely to turn bad will reach an unprecedented 5.3 trillion rupees ($83 billion) in the same period.

“It may not always be practical for the banks to replace management of a company and then to oversee the new set of consultants or turn around specialists who may try to run the company,” Mukherjee said. “There are many operational challenges in implementing this new debt conversion scheme.”