The Reserve Bank of India's newest measure to compete with the country's limp bankruptcy laws and overburdened legal system has given Indian banks an important strategic advantage in their long battle against the promoters of defaulting companies.
The new rules issued, allow lenders to take a majority stake in defaulting companies. In the RBI's new debt restructuring scheme, banks will be allowed to convert all or part of their loan, plus interest, into a majority stake of 51 per cent, if a borrower fails to meet certain milestones, assuming that the debt-for-equity swap has 75 per cent approval. Current laws of loan recasts lean in the favour of the promoters where banks are practically held hostage by those who know that the lenders will have to work with them. These debt recasts often involve bankers into putting additional money. The new law will give the banks the right to convert their loans into shares in case the promoters do not keep their promises.
RBI governor Raghuram Rajan’s plans are timely and could do much to revive the health of India’s banking sector. It is struggling to finance the government’s ambitious plans to boost growth and improve national infrastructure. If used properly, the new scheme will prevent taxpayer-funded banks from picking up the tab after corporate screw-ups such as Kingfisher Airlines which collapsed in 2012 amid huge losses.
“In India, too many large borrowers insist on their divine right to stay in control despite their unwillingness to put in new money,” Rajan had rightly pointed out last year. The new norms will give more power to banks during negotiations about debt recasts, but they cannot be seen as the end game for policy makers. India eventually needs a strong bankruptcy law. Privatisation would help to restore banks to better state, by ensuring stronger management and a firmer grip on lending, although the Indian government does not seem too enthusiastic about it. As checks are high, no Indian bank has been in currency racket or PPP or fraudulence.