What drove the Securities and Exchange Board of India (Sebi) to hold back its directive requiring companies to inform stock exchanges about defaults on loan payments to banks and financial institutions?
It’s not the outcome of hectic lobbying by corporate groups but emanated from concerns over the likely impact of such information on balance sheets of banks which are struggling with sticky loans.
The regulator’s announcement — coming just before a long weekend — to postpone the implementation of the directive “until further notice” surprised everyone in the financial markets.
What was the trigger? Senior officials in the financial services industry told ET that in recent meetings, bankers had conveyed to credit rating agencies the possible impact of such disclosure on their books.
Here’s how it could play out. Sharing information on default with exchanges would compel rating agencies to straightaway downgrade a loan to ‘D’ or default grade. Such an event would be immediately factored into while calculating the minimum capital needs of banks The floor capital adequacy level for a bank is the ratio of different kinds of bank capital (equity, free reserves, secondary bonds etc.) to its risk-weighted assets.
Since a ‘default rating’ on a loan would sharply raise the risk weight attached to the loan in question, a downgrade would thus lower the capital adequacy ratio of a bank – an event that would require a bank to arrange more capital to sustain the same level of business.
Unlike a default on bond — which investors immediately get a whiff of — news of a loan default rarely leaks out. Banks categorise a loan as nonperforming asset (NPA) three months after a default. If a borrower services the loan after a few weeks of delay, it is not reflected on lenders’ books as the loan is regularised within the 90-day window.
Only when a borrower fails to repay within 90 days, analysts and investors come to know about a corporate default and classification of the loan as NPA.
Banks had told agencies that initial default or delay is common among borrowers and reporting each nonpayment of interest or principal or even processing fee could cause a downgrade of several loans.
Also, since many of these payments happen after some delay (but before 90 days), a default tag would not only trigger hardship for the borrower but also stress capital levels of banks.
Indeed, banks had refused to share information on loan default even with rating agencies.
The issue came to the fore in May 2017 when the market regulator Sebi asked rating agencies to explain what lead to the downgrade of Reliance Communications’ debt securities and loans by several swift notches. Sebi had then wanted to know whether investors of RCom securities could have been alerted with an early rating action.