Srikanth Vadlamani, VP -Senior Analyst, Financial Institutions Group, Moody's Investors Service Singapore
On 5 January, the Securities Exchange Board of India (SEBI), the capital markets regulator, posted a discussion paper that proposes restrictions on borrowers who have deliberately not repaid loans despite adequate resources or who have engaged in fraudulent transactions such as siphoning off funds. Such borrowers would be barred from accessing capital markets to issue debt and most forms of equity.Additionally, these so-called wilful defaulters would be denied additional facilities by any bank or other financial institution. The proposal, if implemented, is credit positive for Indian banks because it would be an additional disincentive to borrowers from becoming wilful defaulters.
In SEBI's proposal, an issuer, its controlling/key shareholder, group company or director on the list of wilful defaulters would be prohibited from a public issue of equity shares, debt securities, and preference shares. It would also be prohibited from controlling any other listed entity. Currently, willful defaulters are only prohibited from issuing convertible debt instruments. They will, however, be allowed to make a rights issue or a private placement to qualified institutional investors. The list itself would be maintained by a central repository authority, although not SEBI, and banks would provide willful defaulters names to the authority.
Low recoveries from defaulted corporate loans, despite most of these being collateralized, has been credit negative for Indian banks. The weakness has been particularly apparent in the current credit cycle, which has seen a sharp pick-up in corporate nonperforming loans. Low recoveries have been driven to a material extent by influential key shareholders using weakness in the legal system to make recoveries by way of liquidating collateral an inordinately lengthy process. This, in turn, often led banks to renegotiate loans with terms that were unfavorable to the banks.
India's central bank, the Reserve Bank of India, has taken steps to strengthen banks' bargaining power with recalcitrant large borrowers. Key regulations on this front include norms for classifying borrowers as willful defaulters in July 2012 and as non-cooperative borrowers (i.e., those borrowers who deliberately attempt to delay and inhibit the recovery process after due legal process has been followed) in December last year. These measures aim to create disincentives for borrowers from being uncooperative with banks in the resolution of bad loans. The SEBI's proposed regulations would further this objective.
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Indian public sector banks that have high levels of impaired loans, shown below, would be the key beneficiaries of the SEBI's proposal.
The ability of Indian public-sector banks to raise equity from the markets improved this year amid an increase in bank share prices, as reflected by a 90% jump in India's National Stock Exchange CNX Bank Nifty Index over the past year. Nonetheless, many of the banks still trade at a substantial discount to book value, compared with Indian private-sector banks, which traded at price-to-book multiples of 2.5x- 4.6x as of 15 December.
We expect those public-sector banks trading at higher price-to-book ratios, including State Bank of India (Baa3 stable, D+/ba1 negative), at 1.5x, and Bank of Baroda (Baa3 stable, D/ba2 negative), at 1.2x, to have an easier time raising equity capital. But the cabinet is also providing weaker public-sector banks with lower price-to-book ratios greater latitude to raise capital, since majority shareholder dilution will be less of a constraint.
Even if the government's stake in these banks declines, we do not expect a decrease in systemic support for senior creditors, given that the government will retain controlling interests in the banks. Also, a default of senior obligations at any single public-sector bank would have high risk of contagion given that public-sector banks hold more than 70% of India's banking system assets.
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