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Insights into Editorial: S4A won’t solve the bad loans problem

Insights into Editorial: S4A won’t solve the bad loans problem

Article LInk

28 June 2016

Stocks of lenders and debt-ridden companies have been rallying ever since the RBI announced a scheme for sustainable structuring of stressed assets, which allows banks to convert up to half the loans held by corporate borrowers into equity or equity-like securities. It was believed that the scheme, dubbed as Scheme for Sustainable Structuring of Stressed Assets (S4A), is positive for both lenders and borrowers in the long term.

What is the scheme all about?

It is a scheme for resolution of bad loans of large projects wherein a portion of the debt will be converted into equity or other instruments under supervision of IBA’s Overseeing Committee.

  • It envisages determination of the sustainable debt level for a stressed borrower, and bifurcation of the outstanding debt into sustainable debt and equity/quasi-equity instruments which are expected to provide upside to the lenders when the borrower turns around.
  • The Scheme will cover those projects which have started commercial operations and have outstanding loan of over Rs 500 crore.
  • In order to ensure transparency, an Overseeing Committee, set up by the Indian Banks Association (IBA) and comprising of eminent experts, will independently review the processes involved in preparation of the resolution plan. The panel will be set up in consultation with the RBI.
  • As per the resolution plan, the debt will be divided into two parts — Part A will include debt which can be serviced from the existing operation while remaining will be classified as Part B. While there will be no extension of the repayment of Part A, the Part B will be converted into equity/redeemable cumulative optionally convertible preference shares. However, in cases where the resolution plan does not involve change in promoter, banks may, at their discretion, also convert a portion of Part B into optionally convertible debentures.
  • Banks will also need to set aside higher provisions if they choose to follow this route. Lenders will have to make provisions to the extent of 20% of the total outstanding amount or 40% of the amount of debt that is seen as unsustainable.
  • Of these two, the amount that is higher will equal the amount of provisions that a bank has to set aside. These provisions are higher than the 15% that banks make for an NPA in the first year but lower than the 100% in provisions required over a three-year period.

Why this was needed?

The move is intended to help restore the flow of credit to crucial sectors such as infrastructure and iron and steel, among others, reduce the stress on corporate borrowers and stanch bad loans across banks.

  • The gross bad loans of 39 listed Indian banks, in absolute term, rose 92% in fiscal year 2016 to Rs.5.79 trillion even as after provisioning, the net bad loans more than doubled to Rs.3.38 trillion.
  • In percentage terms, the average gross non-performing assets (NPAs) of this group of banks rose from 4.41% of loans in 2015 to 7.91% in 2016; net NPAs in the past one year rose from 2.45% to 4.63%.
  • Public sector banks, which have close to 70% market share of loans, are more affected than their private sector peers. Two of them have over 15% gross NPAs and an additional eight close to 10% and more.
  • If we include restructured loans as well as those loans that have been written off, the total stressed assets could be as much as one-fourth of loans, at least for some of the government-owned banks.

What’s necessary for successful implementation of this scheme?

  1. Ability of banks to apportion loans into sustainable and unsustainable.
  2. Availability of un-impaired capital of banks.
  3. Ability of banks to ensure that promoter’s skin is still in the game after implementation of the scheme.

How is it different from SDR scheme?

The new scheme is better than the Strategic Debt Restructuring (SDR) scheme as entire corporate debt need not be classified as non-performing assets, and existing promoters can also continue. In SDR, banks had the option to convert debt into equity and take control of the company to sell off the assets.

Also, under SDR, a consortium of lenders can convert part of their loan exposure in a stressed company into equity and own at least 51% of it. The banks were also given a window of 18 months to bring the houses of stressed companies in order.


  • This scheme would not only strengthen the lenders’ ability to deal with stressed assets, but would also put real assets back on track, benefitting both banks and the promoters of troubled entities.
  • The move is intended to help restore the flow of credit to crucial sectors such as infrastructure and iron and steel, among others, reduce the stress on corporate borrowers and stanch bad loans across banks.

What’s not so good in this?

  • In its current form, the reform could favour promoters more than the underlying lenders because banks have to provide for the loss of interest from their profit, while promoters get away with lower interest payments.
  • The scheme can only be used for operational projects. Banks cannot reschedule or reprice the debt that is remaining after converting part of it into equity. Also, they have to assess the sustainable portion of the debt based on current cash flows rather than any future projection of cash flows. Due to this, many firms would not be able to do much for some power projects which are still under implementation.
  • It also does not allow for banks to change the terms and conditions of the loan. This would mean that not too much support to the sustainable part of the debt can be extended.
  • The oversight committee will help give comfort to bankers. However, the overseeing committee might slow the process a little but it is a necessary evil, as it gives a lot of comfort to the bankers.
  • The guidelines say that while calculating the sustainable part of the debt, banks need to ensure that this part of the debt can be serviced over the original tenor even if the future cash flows remain at their current level. A number of stressed companies are functioning at such sub-optimal levels that they need constant working capital support.
  • Another concern could be the high level of equity dilution that may result from a scheme of this nature. This could be negative for shareholders and may also reduce the incentive for promoters to actually turn around the company.
  • Banks are required to set aside a large amount of provision as part of this scheme, which would deeply affect not only the value of the loan, but also the profitability of banks as some of these cases are large.


S4A sounds like a car model, but the ride may not be all that smooth for the banking system. To make it smoother, both RBI and the government should identify the loopholes and address them as soon as possible.