Banks need to be more transparent about loan restructuring

Restructuring is a polite form of default. The only difference between restructured loans and default is that the lender has to write off or make provisions for the latter while the former stays on books as assets. The borrower going in for restructuring does not have money to repay loans or service the loans.

In the case of a bond, the market will force the holder to devalue the defaulted bond. The market will pull down the price of the bond that is facing default, leaving the bondholder no choice but to take the loss on his books.

Indian banks are seeing record amount of loans being restructured with Rs 1.25 lakh crores being restructured in 2011-12 and further Rs 2 lakh crores expected to be restructured in 2012-13, as per CRISIL estimates.

Restructured loans will form 3.5 percent of advances if Rs 2 lakh crores get restructured in 2012-13. Reuters

Restructured loans will form 3.5 percent of advances if Rs 2 lakh crores get restructured in 2012-13. The issue faced by shareholders of banks that restructure loans is the lack of clarity on the real position of the balance sheets of the banks.

Restructured loans do not appear as non-performing assets (NPAs) but there is likelihood that the loans will become NPAs down the lane. Past experience shows that 20 percent of restructured loans will turn bad and shareholders should knock off 20 percent from a bank's balance sheet to arrive at capital adequacy and return ratios.

However, the past is no guarantee for the future and unless banks disclose the names of all borrowers whose loans have been restructured, shareholders will be left in the dark on the true nature of a lender's balance sheet.

Needless to say, problem of restructured loans surface during troubled times-when capital market volatility is extreme or stress on balance sheets of European banks increases.

Markets will take the only course it can take when there is volatility, it will pull down prices of all lenders who have exposure to restructured loans. This can lead to a self fulfilling cycle of banks being knocked down, leading to a complete clampdown on lending. Even loans that could possibly come out of restructuring get pulled into the non-performing category.

One way to estimate the true value of restructured loans is to let the market do it. Banks should get the loans rated (which is happening anyway) and then give it to an external valuation agency such as CRISIL or ICRA to value the bond.

CRISIL should use indicative quotes from non-interested market participants to value the bonds. The lenders should then value the loans as per the valuation estimates of the external agency. Shareholders will then have a much better picture of the lender's financial position and can then take calculated investment decisions.

The lender can maintain client confidentiality and not disclose the names of borrowers who have gone in for restructuring.

The true value of the loans held in books of the lenders will be sufficient information for shareholders. The valuation exercise can be done on a regular basis, once a quarter to reflect the market movements and change in the borrowers' profile.

The stress in Spanish banks had pushed up government bonds yields there to euro era record. This was due to the fact that the market did not know the true value of the banks' loan books.

Spanish banks have a large exposure to real estate loans in Spain, which has seen a property bubble burst.

China is another country where there is no transparency on this front. There is a large amount of speculation on the survival of banks in China, leading to the country's equity market staying down 50 percent from the highs seen in 2007-08.

The sooner Indian lenders adopt more transparent methods of valuing restructured assets the better, else they will be forced to, during troubled times.

Arjun Parthasarathy is the Editor of a web site for investors.

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Updated Date: Dec 20, 2014 09:57:38 IST

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