RBI’s new restructuring tool 'S4A' to raise banks’ moral hazard risk

MUMBAI: The Reserve Bank of India’s ( RBI) new restructuring tool unveiled on Monday will raise banks’ moral hazard risk because the high debt of these over-leveraged companies means their market capitalisation does not match the haircuts banks are likely to take.

Under a new ‘Scheme for Sustainable Structuring of Stressed Assets’ ( S4A), RBI allowed banks to take equity in debt laden firms permitting them to split total loans of struggling companies into sustainable and unsustainable based on the cash flows of the projects.

Banks were allowed to continue loans that had current or future cash flows as sustainable or Part A, while the remaining unsustainable debt could be converted into equity or a convertible security.

Credit Suisse analysts Ashish Gupta, Prashant Kumar and Kush Shah pointed out that the debt to market-cap levels of these overleveraged companies are between six and 50 times, much higher than the haircuts that banks are likely to take.

“Therefore, while these regulations may help reduce the unsustainable leverage at some of the large borrowers, it may raise the moral hazard risks on the bank’s books,” Credit Suisse said.

The analysts gave a list of nine companies in which the amount of haircut banks have to take ranges from 0.6 to 32 times the market capitalisation. “Therefore, while these regulations may help reduce the unsustainable leverage at some of the large borrowers, it may raise the ‘moral hazard’ risks on the bank’s books,” they said.

Moral hazard is the risk that a company may not enter into a contract in good faith and provide misleading information about its assets, liabilities or credit capacity.