It is surprising there is so little discussion and worries about October 3. What is important about that date? It’s the day when market regulator SEBI’s seismic rule kicks in requiring all companies to announce their loan defaults to banks within one working day (The principle officially kicks in on October 1, but October 1 and 2 are trading holidays).
At the start, it has to be stated that this rule itself is a welcome revolution, a much-needed cleansing of the banking system and its nexus with corporate India. For too long now, there’s been huge opacity in terms of the number of companies are paying back their loans leading to the current accumulation of Non-performing assets (NPAs) or nonperforming loans with banks. Had this rule been put in the novels in 2010 or 2012, this kind of accumulation of NPAs may not have come to pass.
Also, there are individuals who believe that thanks to the AQR or the strength quality review by Reserve Bank of India in 2015, the majority of the big NPAs or defaults are well and widely known and hence starting October, nothing new is going to be shown which can rattle the stock markets.
Additionally, there are other people who believe that like the GST, there will be temporary disruptions, but things will settle down as those who default by a few days pay back as well as the fresh disclosure reassures markets.
The truth is most bankers, rating agencies, brokerages, and companies are uncertain how this will play out and some are terribly worried.
This is why.
Bankers say non-payment of interest to banks even by a day may direct rating agencies to immediately downgrade the lender facilities of the companies to “D”. Bank loans to companies rated “D” in turn will have to be supported with higher risk capital. Given that banks are already facing the prospect of large demand for capital to meet NPA and bankruptcy cases, this fresh onslaught can stretch them.
What is worse, once a business is graded “D”, banks might even be unwilling to give them fresh loans since even these will attract higher risk capital. Hence, what may be a couple of days’ default option for a few innocuous reason may lead to stoppage of credit and thus stoppage of production for a longish period.
The SEBI rule comes at a particularly inopportune time when liquidity in the system is already quite tight because of their Goods & Services Tax or the GST. Exporters have not got their Integrated GST (IGST) credits from the government since the system is still not completely functional.
With the money situation already tight, the Odds of hundreds even Thousands of companies defaulting by a couple of days is very likely. And if their lender facilities are immediately rated “D” from the rating agencies, and the banks, therefore, refuse to lend additional credit, many companies can go out of business temporarily. Like under demonetization and GST, some may not possess the buffer to stay place and may go out of business indefinitely.
It is possible things may not play out so badly. Companies may borrow in their collection companies and associates and avoid default, knowing the outcomes. In many cases, it may only be a case of disciplining cash flows to pay on the 29th day, unlike the recent procedures which are designed to pay on the 89th day.
Also, some experts say the majority of the loans in India are given by banks on a money credit basis, and the danger of default in these cases is low since companies rarely borrow up to their limit.
Some also Argue that most of the stressed companies are already in the SMA1 or SMA2 category. (SMA is special mention class; SMA1 comprises loans where interest hasn’t been paid within 30 days, and SMA2 are those where interest is finished due by over 60 days). Banks are already aware of these.
However, some bankers state being aware of a stressed loan is not the same as having to provide additional risk capital for them. Starting October, they say, most banks can grow to be even more averse to lending, and the aversion will start even as the “active” season for business begins. In addition, companies hardly recovering from demonetization and GST might be unable to survive in the surface of the fresh squeeze on capital.
All this might not occur, but maybe the regulators — both SEBI and RBI — need to call bankers and rating agencies and contemplate over how the rule might be actually implemented without killing the spirit of the rule or the businesses.