Corporate Debt Restructuring and Bank Stability: Evidence From India
Mrigakshi Das, Subhendu Patnaik, T. K. Krishna Kumar, Vidya Pujari
Doctoral Candidates, Xavier University, Bhubaneswar, INDIA
Published Online: October 28, 2015
Note. This report is based on a seminar delivered by Sushanta Mallick, Professor of International Finance, School of Business and Management, Queen Mary University of London, UK, at Xavier Institute of Management, Xavier University, Bhubaneswar, India, on August 6, 2015.
Banking regulators around the world aim at maintaining competition and stability in the banking sector. These are also the objectives of central banks such as the Reserve Bank of India (RBI). Since the year 2000, Indian corporates have faced increasing challenges in meeting their debt servicing obligations to banks and financial institutions. This posed a risk to banks’ balance sheets and their financial stability due to increasing non-performing loans and corporate bankruptcies. Similar situations have occurred in other emerging market economies too. Over the last two decades, banking systems in many emerging market economies have passed through major reforms including restructuring programmes, in the form of corporate debt restructuring (CDR) programme, to reduce bank-level non-performing assets. Debt restructuring refers to modifying the terms of a loan, so as to offer the debtor some opportunity to build up their debt servicing capacity.
The seminar focused on Ahamed and Mallick’s (2014) research that empirically investigated whether member banks benefitted from restructuring of corporate debts. Furthermore, their research also examined how the market power of banks influences their risk and whether CDR programmes reduce the risk of banks.
Corporate Debt Restructuring
During the late 1990s, Indian corporations encountered severe financial distress in terms of meeting repayment obligations. In this period the Indian credit market faced a downward spiral. To mitigate this problem RBI initiated a debt restructuring (CDR) mechanism in the year 2002. Prior to this CDR programme, the Board for Industrial and Financial Reconstruction (BIFR) was set up under the Sick Industrial Companies Act, 1985, to determine the sickness of industrial companies and to help entrepreneurs to rehabilitate economically feasible industrial units. BIFR was also the competent institution to dispose of economically infeasible industrial units. BIFR is an agency of the Government of India which functions similar to Chapter 11 of the United States Bankruptcy Code.
It was observed that there was misuse of the provisions of BIFR and it resulted in an increase of bad debt for financial institutions. To avoid such a problem, a new act was enacted: the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 (SARFAESI Act). This new law allows financial institutions to confiscate the fixed assets of the borrowers without any meditation from the judicial system. Borrowers who are not eligible to get relief under the purview of BIFR regulations are automatically covered under the SARFAESI Act. However, most of the financial institutions offer initial relief to borrowers to restructure their loans (i.e., defer the repayment schedule) under the CDR programme. In the event of subsequent default, borrowers are invariably subjected to the provisions of the SARFAESI Act.
Hypothesis 2a. CDR can have a positive effect on stability of member banks.
Ahamed and Mallick are of the opinion that “alluded concessional loan loss provisions on restructured corporate loans have direct implications on the mark-up of the banks and their market power” (Ahamed & Mallick, 2014, p. 10). These authors note that “due to increasing market power, member banks may have shown delinquency in determining the riskiness of their portfolios” (Ahamed & Mallick, 2014, p. 10). Further, they point out that “since the aim of the financial reforms was to enhance market mechanism, transparency, and banking competition, we may expect an individual bank’s pricing power can channel through CDR and induce excessive risk-taking” (p. 10).Therefore, Ahamed and Mallick (2014) expected that CDR would influence an individual bank’s pricing power and accordingly, they formulated the following hypothesis:
Hypothesis 2b. The positive effect of CDR on stability reduces at higher degree of market power.
The result of this study indicates that after implementation of the CDR mechanism, stability of member banks increased by 43.6% (Ahamed & Mallik, 2014). The following issues were discussed after the result was presented in the seminar. It was pointed out that implementation of the CDR programme is not compulsory. In most cases, private banks in India do not extend facilities under the CDR mechanism; rather they invoke the provisions of the SARFAESI Act and undertake action to confiscate the collateral securities. Thereby they recover their legitimate dues. This led to a discussion on whether the study should have incorporated the effect of bank’s ownership (i.e., public sector versus private sector) in evaluating the impact of the CDR programme. Mallick clarified, the study was limited to banks that followed the CDR mechanism; therefore such a comparison could not be made.
Suggested Citation: Das, M., Patnaik, S., Krishna Kumar, T. K., & Pujari, V. (2015). Corporate debt restructuring and bank stability: Evidence from India. Research World, 12, Article S12.4. Retrieved from http://www1.ximb.ac.in/RW.nsf/pages/S12.4
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