Author: Kala Rao
India
When four foreign creditors refused to go along with a debt-recast plan for Arvind Mills, a leading clothing manufacturer that has hit hard times, it created something of a sensation in Indian financial circles. Then one of the creditors, Commerzbank, filed a criminal suit against top officials of the company and against ICICI, one of the biggest Indian banks and Arvind Mills’ principal creditor, and things began to look ugly. Now a new central bank directive laying out ground rules for restructuring corporate debt seemingly gives big creditors a boost, and has bankers whispering about infringement of creditors’ rights.
The Reserve Bank of India’s new rule stipulates that when lenders accounting for three-quarters of a borrower’s secured debt agree to bail the debtor out, the minority creditors will be legally bound to go along with them. The rule is meant to discourage delays caused by lengthy litigation by individual creditors in cases where the borrower is solvent but faces a genuine liquidity problem caused by a business downturn. But, as the Arvind Mills case reveals, creditors can have widely differing views and concerns.
Arvind Mills’ dissenting creditors – Commerzbank, Bank of Nova Scotia and Dai-Ichi Kangyo Bank – allege that assets mortgaged to lenders were sold to pay off the company’s biggest secured creditor, ICICI, and other assets were diverted to subsidiaries. “When creditors are being asked to make a sacrifice, it is only fair that money taken out of the company must be put back in,” says Pradeep Kumar, head of the legal division at Commerzbank. The German bank, which has an exposure of around Rs430 million (under $10 million) to Arvind has turned aggressive. It filed a criminal suit in July against top officials at ICICI alleging a fiduciary breach of trust. ICICI is a security trustee to foreign lenders of Arvind.
Another spat between creditors of the controversial Dabhol Power Company promoted by Texas energy giant Enron has exposed a growing conflict of interest between Indian and foreign creditors. Indian creditors, generally the biggest ones, tend to forgive an errant borrower easily, partly to escape making provisions on those loans, while foreign creditors are ready to punish them. Foreign creditors of DPC refused to disburse more money after the state utility defaulted on payments to the company, forcing it to halt construction of the $3 billion plant. Indian creditors, led by the Industrial Development Bank of India, a big state bank, have cut interest rates on rupee loans to DPC and fought a move by foreign creditors to terminate the project. They are currently negotiating a deal to buy out Enron and possibly the foreign creditors in the project.
Indian regulators privately voice disapproval of the haste with which some foreign banks are calling in their loans to a troubled borrower rather than working through its problems. A banker from State Bank of India, the largest commercial bank, points out: “Foreign creditors are eager to settle quickly rather than go for a long rescheduling of debt.” Jaspal Bindra, regional head at Standard Chartered Grindlays, one of the oldest-established foreign banks in India, says restructuring corporate debt usually means taking longer-term exposures. “Foreign banks might not want to have long-tenor loans on their books and would rather take a discounted value on the principal,” he says. He concedes that bigger creditors tend to get stuck with a borrower because paying them off is more difficult.
The new rules will give clout to big creditors, mostly Indian banks, to have their way. This includes a decision on whether a troubled borrower is solvent, and therefore deserves help. GM Ramamurthy, chief general manager, Industrial Development Bank of India, who helped draft the rules, says they are in line with similar legislation in the UK, South Korea, Thailand and Malaysia. “Some of those countries have made this a law,” he says. “In India we have made it a central bank directive to avoid the delay of getting parliamentary approval. If lenders in a syndicate accounting for three-fourths of secured debt agree to the terms of debt relief a borrower deserves, they can go against the will of other minority creditors,” he says. The rule only applies to syndicated loans of over Rs200 million that are not in default.
Bankers are split on whether the system will work. One foreign banker says: “Dissenting creditors might not have a choice when it comes to making a sacrifice, but they cannot be expected to advance fresh loans.” Others argue that the rule could deter banks from getting tangled in India’s painful legal system and encourage them to settle disputes outside.
Most agree that compulsion imposed on any creditors does not work. “Banks have their own relationships and collateral agreements with a borrower,” says Standard Chartered’s Bindra. “Unless there is a common understanding among them, it is not likely to work.” Foreign banks are unlikely to change their lending strategy because of the new rule, he adds.
The second and perhaps more important change in regulation for foreign banks in India comes in April next year. The central bank has ruled that foreign-currency loans to Indian companies can no longer be counted as part of the capital of a foreign bank. Recently, it reduced the limit on a bank’s loans to an individual borrower from 20% to 15% of its capital funds. Taken together, foreign banks will see a sharp fall in their credit limits for Indian borrowers. They will have to bring in more capital to support their loans to Indian companies or shrink their loan books.
RBI officials point out that the new rule is in line with the proposed Basle capital accord. Moreover, it is only treating foreign banks on a par with Indian banks. Foreign banks can set up shop in India with just $10 million in capital, while new Indian banks must cough up around $42 million. Foreign banks, in turn, say that they must be free, like Indian banks, to open branches anywhere in India. Under its obligations to the World Trade Organization, India has said it will allow foreign banks to open at least 12 new branches each year, but it allowed 15 last year.
Current regulations allow the 42-odd foreign banks in India to open branches in the country – they cannot be incorporated in the country as commercial banks. They must assign $10 million as capital when they open their first and second branch in the country, and $5 million for each branch thereafter.
Z Cama, chief executive of HSBC in India, says: “As branches of a global bank, our liability here is covered by our parent bank’s capital, which is huge. The liability of Indian banks [incorporated in India], however, is limited to the extent of the capital they own here.” Standard Chartered’s Bindra says that the big foreign banks will not be affected much by the new capital rule as they have sizeable capital in India, but smaller one-branch banks will be hit.
Commerzbank, which operates just one branch in India, has decided to surrender its banking licence and keep a representative office in India rather than bring in fresh capital. Others, such as Dresdner, are reportedly winding down their operations.
Several foreign banks have made representations to the central bank to give them some leeway. The head of a Singapore-based bank says: “We are asking the regulators if loans from our parent bank will be eligible as tier II capital.” As the central bank weighs up their plea, foreign banks have begun to assess the costs of doing business in India.
