Over the last few years asset quality of banks in India has come under tremendous pressure; more so of the public sector banks. Until the last financial year (i.e. FY14) gross Non-Preforming Assets of banks touched 4.1% (up from 3.6% in FY13) and this financial year too, the pressure would persist. According to ICRA (an Indian rating agency), the gross NPAs in the entire banking system had increased to 4.5% of the total assets as of December-end. Tough economic conditions and higher interest rates have weighed in, resulting in the slippage of the quality of assets of Indian banks. Moreover, lapse in risk management processes is also responsible for the poor asset quality. But now a decision by the capital market regulator, the Securities and Exchange Board of India (SEBI) is aimed to alleviate this problem faced by banks.

What has SEBI done?
SEBI has approved a proposal prepared in consultation with Reserve Bank of India (RBI) to relax the applicability of certain provisions of the SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2009 and the SEBI (Substantial Acquisition of Shares and Takeovers) Regulations, 2011 in cases of conversion of debt into equity of listed borrower companies in distress by the lending institutions.

The basis of conversion…
Well, such relaxation in terms of pricing will be subject to the allotment price being as per a fair price formula prescribed and not being less than the face value of shares. Other requirements would be available if conversions are undertaken as part of the proposed Strategic Debt Restructuring (SDR) scheme of RBI. This is intended to revive such listed companies and provide more flexibility to the lending institutions to acquire control over the company in the process of restructuring, to the benefit of all the stakeholders.

While the fine print for conversion from debt to equity is yet to be issued, it is perceived to be on fair pricing and would be linked to the conditions of the company i.e. its fundamentals. This in turn would make things simpler for the lender and the promoter of the company, as they would derive at a fair price (as per the prescribed formula) without having to worry about secondary market price. In the past, it was observed that while some companies converted their debt into equity, the conversion price commanded a premium over the market price.

So, SEBI has eased the norms while providing certain safeguards, including by asking banks to acquire at least 51% equity. This will enable the creditor to get a controlling equity stake in the borrower company in exchange for full or partial cancellation of its debt claims against the company. In other words, it will allow the lender of a defaulting borrower firm to take full control over the latter and will minimize the chances of liquidation for the company, albeit at the cost of management control of the original promoter.

The new proposals to ease conversion norms will have no immediate effect on the NPA’s of banks. However it will give them the ability to acquire the equity assets at the right price. When they are able to convert at the right price, the lenders will have close to 51% and it will be easy to lookout for a buyer who will be interested in distressed assets. This would lessen the burden of NPAs on banks in time to come.

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