Twin Balance Sheet Problem - Features, Significance [UPSC Notes] (2024)

The Twin Balance Sheet problem refers to the situation of overleveraged companies on one hand and bad-loan-encumbered banks on the other.

This has been an issue lingering for decades in the Indian economy, albeit in different forms and structural names. All IAS Exam aspirants must go through the details discussed below.

Twin Balance Sheet Problem [UPSC Notes]:-Download PDF Here

Common Feature of a Twin Balance Sheet Problem in an Economy

• Corporate sector over-expand during a period of boom, leaving them with obligations that they can’t repay.
• This leads to the defaulting of debts by the corporate companies, leaving the lender, the bank’s balance sheets impaired.
• The terrible situation is an uncalled-for situation, devastating for the growth scenario.
• It is devastating for growth, the corporate sector limping in such a trap, are often reluctant to invest and the ones with stable, sound financial health don’t show much interest to invest.
• Similarly, banks are also in a terrible financial crisis, due to the Non Performing Assets, limiting and choking their ability to lend in such a scenario

Origin and evolution of the crisis

• The origins of the NPA problem can be traced to various policy decisions taken during the mid-2000s.
• Economies of the world were on a boom, with India’s astonishing GDP growth rising to 9-10 percent per annum.
• During the boom period of mid-2000s, state-run banks kept on lending while the corporate sector — especially infra companies — saw a period of robust growth fuelled by easily available credit.
• Corporate profitability was amongst the highest in the world, encouraging firms to hire labour aggressively, this in turn sent wages soaring.
• With the excitement of sustaining a prolonged double digit growth, firms abandoned their conservative debt/equity ratios and leveraged themselves up to take advantage of the perceived opportunities
• In the span of just three years, from 2004-05 to 2008-09, the amount of non-food bank credit doubled, thereby increasing the financing costs sharply.
• Global Financial Crisis (2007-08) hampered the growth, affecting the revenue generation from such investments.
• The assumption of sustaining a magical double digit growth rate proved to be a fallacy, and the growth rate plummeted thereby affecting revenue generation.
• Firms borrowing domestically suffered when the RBI increased interest rates to negate double-digit inflation further sending the prospects of repayment or recovery of loans on a downward spiral.
• And firms that had borrowed abroad at that time with better trading valuation of Rupees Vis-a-vis Dollar, incurred great loss when they were forced to repay the debt, at a much higher rate due to depreciation of rupee, at much higher exchange rates.
• Higher costs, lower revenues, greater financing costs, all combined to reduce the corporate cash flow, quickly leading to debt servicing problems.
• By 2013, nearly one-third of corporate debt was owed by companies with an interest coverage ratio less than 1, mostly in the crucial Power infrastructure and metals sectors.
• By 2015, the share of companies with interest coverage ratio less than 1, touched nearly 40 percent, due to slow growth in China, leading international steel prices to collapse.
• It contributed to heavy losses to the balance sheets of major Indian steel companies.
• Companies took more risks, resorting to aggressive loans, and things went wrong.
• Costs soared far above budgeted levels, due to administrative delays in clearances for land and environment, delaying the overall effective running of the projects.

What are the Steps taken by the Government to address NPA or Twin-balance Sheet conundrum?

The 5/25 Refinancing of Infrastructure Scheme

• Offered a larger window for the revival of stressed assets in the infrastructure sectors and eight-core industrial sectors
• Under these, lenders were allowed to extend amortisation periods to 25 years, with interest rates adjusted every 5 year.
• This was intended to match the funding period with the long gestation and productive life of the projects.
• The scheme thus aimed to improve the credit profile and liquidity position of borrowers, allowing banks to treat these loans as standard in their balance sheets, reducing provisioning costs.
• However, with amortisation spread out over a longer period, this arrangement also meant that the companies faced a higher interest burden, which they found difficult to repay, forcing banks to extend additional loans.
• A peculiar situation of ever-greening of the NPA emerged.
• This in turn has aggravated the initial problem.

Private Asset Reconstruction Companies (ARCs)

• ARCs were introduced to India under the SARFAESI Act (2002), with the notion that as specialists in the task of resolving problem loans, they could relieve banks of this burden.
• ARCs found it difficult to resolve the assets they have purchased, so they are only willing to purchase loans at low prices.
• Banks were unwilling to sell them loans on a large scale.
• In 2014 the fee structure of the ARCs was modified, requiring ARCs to pay a greater proportion of the purchase price up-front in cash.
• Owing to the slowed-down number of sales, only about 5 percent of total NPAs at book value were sold over 2014-15 and 2015-16.

To know what are Asset Reconstruction Companies, candidates can visit the linked article.

Strategic Debt Restructuring (SDR)

• The RBI came up with the SDR scheme in June 2015 to provide an opportunity to banks to convert debt of companies
• It was meant for companies whose stressed assets were restructured but which could not finally fulfil the conditions attached to the restructuring exercise.
• It was fixed to sell at 51 percent equity to the highest bidders, subject to authorization by existing shareholders.
• An 18-month period was envisaged for these transactions, during which the loans could be classified as performing.
• But as of end-December 2016, only two sales had materialized, in part because many firms remained financially unviable
• Only a small portion of the firm’s debt had been converted to equity

Asset Quality Review (AQR)

• Resolution of the problem of bad assets requires sound recognition of such assets.
• Therefore, the RBI emphasized AQR, to verify that banks were assessing loans in line with RBI loan classification rules.
• Any deviations from such rules were to be rectified by March 2016.

Sustainable Structuring of Stressed Assets (S4A)

• Under this arrangement, introduced in June 2016, an independent agency hired by the banks was to decide on how much of the stressed debt of a company is ‘sustainable’.
• The unsustainable ones were to be converted into equity and preference shares.
• Unlike the SDR arrangement, it did not involve any change in the ownership of the company

Why is an agency like Public Sector Asset Rehabilitation Agency (PARA) needed

• The NPA or TBS crisis affected both the banks and certainly a lot of the companies.
• The necessity to deal with the issue is a classic problem of Economics, and so it demands a rational economic approach for better health of the stakeholders.
• The stressed debt is heavily concentrated in large companies.
• Many of these companies were unviable with the levels of debt requiring debt write-downs in many
• Banks found it difficult to resolve these cases, despite a proliferation of schemes to help them
• Delay is costly, demanding a centralised agency like PARA for progress in resolution

What are the Functions of PARA

• It would purchase specified loans from such companies belonging to large, over-indebted infrastructure and steel firms from banks.
• Working out either by converting debt to equity, selling the stakes in auctions or by granting debt reduction, depending on professional assessments of the value-maximizing strategy.
• Once the loans are off the books of the public sector banks, the government would recapitalise them, thereby restoring them to financial health and allowing them to shift their resources – financial and human – back toward the critical task of making new loans.

Funding

• From Capital market
• In the form of securities by the Government through a mechanism by the RBI.

Conclusion

Twin balance sheets are a critical issue affecting the corporate as well as the banking sector, their health and as well as making available credit facilities for new investment. Mechanisms in the past promoting a decentralised approach have seen limited success. It calls for an urgent resolution, addressing the root of the problem as it leads to a stagnation in investment and hampering growth in an economy.

It is expected that a centralised PARA is going to facilitate a faster resolution of the issues. A healthy banking sector, along with an increase in investment, is going to be a boon for our economy in the long run.

Twin Balance Sheet Problem [UPSC Notes]:-Download PDF Here

This article is relevant for the sections of Economics of the UPSC syllabus prescribed for the Preliminary and Main Examination of UPSC Civil Service.

Related Links