Banks can now convert bad debt of borrowers into equity but this new ammunition isn't of much help

Market regulator Securities and exchange board of India (Sebi) has offered a helping hand to Indian banks that are neck-deep in stressed assets by allowing them convert part or full debt of listed, defaulter companies into equity. Under these, banks will be given relaxation from the regular rules that will apply when acquiring significant stake in firms such as an open offer to minority shareholders. The finer details about the pricing and method of conversion will come only in the detailed guidelines. [caption id=“attachment_2168553” align=“alignleft” width=“380”]  AFP image[/caption] Theoretically, the new rule, if it comes with correct pricing for equity conversion for banks, will enable lenders to push a takeover of a firm or exit at a better price. For companies too, this will offer relief since they will be free from interest payments once the debt is converted to equity. However, such a relief might come at the cost of losing  management control. In fact, Sebi has only followed up an earlier rule by the Reserve Bank of India (RBI) in December, to permit banks convert more equity in cases where banks do the recast. But analysts are skeptical about the actual benefit this rule can offer to banks to get rid of the non-performing assets (NPA) burden on their books. Here’s why One, most of the NPAs, restructured assets on the books of banks, is in the infrastructure, manufacturing segments. Many of these firms, with high debt on their book,s have seen their share prices crash in the recent years, resulting in significant erosion in their market caps (see the table). In some cases bank debt is much higher than the market cap. Two, given that the reason for stress in the balance sheets of these firms is due to external factors, delays in projects and slowing demand, in turn, severely impact their cash flows.Not many buyers will be interested in acquiring these firms,which means their future continues to remain uncertain. Third, although easy rules for equity conversion enable banks to take over significant control in the company, banks aren’t in the business of running companies, nor do they have the sector expertise to handle businesses. Till the time banks are unable to find a buyer, equity conversion wouldn’t do much help to banks to recover their bad loans, said Abhishek Kothari, analyst at Quant Capital. “Retrieval of bad loans would require improvement in the operating environment of companies, which wouldn’t happen immediately,’ said Kothari, adding that banks have to make mark-to-market provisions for such exposure. Having said that, bankers are hopeful that ability to convert debt into equity would help provided pricing is correct. Indian banks are sitting on A huge pile of bad and restructured loans, which together constitute about 11 per cent of the total loans given by Indian banks. In recent years, the proportion of stressed assets has gone up substantially in the backdrop of a prolonged slowdown in the economy, absence of fresh investments and lack of reforms pertaining to land acquisition and availability of natural resources. Banks typically do loan recasts in two channels-under the corporate debt restructuring facility (CDR) and through bilateral loan recasts. But, the solution for real recovery in NPAs can only come in the event of strong economic recovery and fresh investments in new and existing projects, bankers said. In short, though the regulatory relaxation in rules pertaining to conversion of debt to equity can indeed offer some relief to banks it wouldn’t do much to recover their money at stake in stressed entities.