Indefensible move

There is no merit in Sebi's about-turn on loan default directive

In a rather curious move, the Securities and Exchange Board of India (Sebi) has decided to hold back its directive which would have made it necessary for listed companies to disclose loan defaults within a day. The circular was withdrawn on September 30, which was just a day before it was supposed to come into effect. Sebi’s decision to suspend the order “until further notice” is an unexpected one as, unlike in the case of a default on a bond where information is readily available, a default on a bank loan does not typically become public information straightaway, even though it is merited. Banks have a grace period of 90 days over which they can categorise a delay as a default. The logic of mandating listed companies to swiftly declare their defaults was a sound one as it would have raised the level of transparency in the system while helping an investor in a company to correctly and promptly assess the risk and rewards involved. Currently, Sebi norms mandate disclosures on delay or default in payment of interest or principal on debt securities. Similar disclosures are not stipulated with regard to bank loans.

The regulator’s about-turn on this issue is indefensible, and seems to have been made under pressure from banks, which fear more damage to their balance sheets. Banks, especially the public sector ones, have argued that ever since the Reserve Bank of India (RBI), under former governor Raghuram Rajan, started an asset quality review, they have been forced to aggressively recognise non-performing assets on their books and, accordingly, make provisions. This has, in turn, led to a massive slippage in profits. They also believe that the Sebi ruling will aggravate the NPA situation. That is because as soon as a company declares that it has defaulted on a loan, the rating agencies downgrade that loan to default grade. This then increases the minimum capital required. But as NPAs have swollen over the past three years, and profitability fallen, banks have a massive and growing need for fresh capital. Making things worse is the central government’s inability to adequately recapitalise banks. In essence, banks have a great incentive to slow down the process that leads to more NPAs being found out. There is an associated issue of timing as well. Sometimes a company fails to meet the initial deadline but pays before the completion of 90 days — the time frame after which a bank has to designate the loan concerned as an NPA. Under the Sebi directive, this leeway would have been lost.

But these are issues that the RBI should figure out. As the capital market regulator, Sebi should consider whether an investor in a company is entitled to be told if the company has defaulted. After all, a loan default is material information that affects stock prices. If the consequential effect on bank balance sheets is excessive in that the entire loan has to be provided for at the rate of 50 per cent immediately, that is an issue of provisioning that the RBI has to consider; it is not Sebi’s lookout. The capital markets regulator should do its dharma, and not wear the hat of the banking regulator.