Recent developments on the corporate debt restructuring (CDR) front suggest that the Indian banking system could be under more stress than the official numbers for non-performing assets (NPAs) seem to indicate. In the first half of the current fiscal year, requests for CDR jumped. According to a report by IDBI Capital, there were 35 CDR requests in the first half of 2011-12, versus 22 in the same period of 2010-11 — and the amount of new debt under CDR consideration shot up to Rs 34,560 crore from Rs 5,180 crore. That’s the highest since recast CDR norms were announced in 2005. This also excludes the mega-liabilities of Air India and Kingfisher, which are known unknowns lurking within the system. The CDR requests are cross-sectoral, reflecting a generic slowdown, coupled to difficulties in servicing loans as rates rise. It is certainly a useful mechanism, allowing creditors and debtors to renegotiate relationships in difficult times. In particular, the CDR mechanism enables creditors to recover their principal and some interest, while allowing the debtor leeway to ward off liquidation. The amount of debt restructured by non-CDR means, via recourse to the more stringent provisions of the BIFR and DRT, is, on average, over five times as large as the CDR amount — so the rising CDR requests could well be a lead indicator for trouble.
Effective systems should not obscure such indicators. The 2008 crisis utterly destroyed the air of sanctity that had hitherto surrounded financial information systems. Rating agencies diced mortgages into bundles that made a mockery of rating exercises. Companies resorted to off-balance sheet accounting, concealing risks in exotic derivatives. Banks and sovereign entities bypassed marking to market of debt, concealing insolvency. As a result, three years on, nobody really knows the damage; few have great faith in balance sheets anymore; and national accounts and ratings are also reckoned unreliable. This has undoubtedly hindered recovery. In the absence of reliable information, the pricing mechanism – and by extension, the market for distressed assets – is broken. India emerged with relatively few scars from 2008, in part due to better due diligence and more stringent reporting and restrictions on exotic instruments and off-balance sheet accounting. However, there are potentially gaping holes in the desi financial information lattice.
One such problem is that, while CDR restructuring generally leads to far more favourable outcomes, it also means a “greening” of potentially bad loans. It is, therefore, reasonable to argue that, once a CDR case is accepted, those debts should no longer be left out of the calculation of NPAs — as they are now, for a period of up to six months. As it stands, the rising trend in CDRs will certainly translate into a bulge on the NPA front over the next two quarters. Data on corporate debt are patchy. It is difficult to guess at dimensions. It would be prudent to assume that official NPA data considerably understate financial stresses. Given that CDRs are clearly useful, the RBI should perhaps work towards a more transparent mechanism for disclosure of CDR exposure. This would offer a great deal of comfort to the investor community.