BackSebi proposes tighter rules for wilful defaulters
Proposals include limiting ways wilful defaulters can raise money, preventing them from acquiring another company
Premium
Mumbai: Stock market watchdog Securities and Exchange Board of India (Sebi) has proposed actions against so-called wilful defaulters, including limiting the ways they can raise money and preventing them from acquiring another company, as regulators move in tandem to address the issue of bad loans and loans threatening to go bad that together account for a little over a tenth of all loans in India’s banking system.
The actions, detailed in a discussion paper released on Monday, follow consultations between Reserve Bank of India (RBI) and Sebi on the need to tighten rules for companies that fail to repay their debt despite having the ability to do so.
RBI governor Raghuram Rajan termed such borrowers freeloaders in a speech on 25 November and argued that these practices had led to a weakening of the credit culture. On 19 November, following a board meeting, Sebi said it would publish a discussion paper on fresh norms for wilful defaulters.
A wilful defaulter, according to RBI guidelines, is one who does not pay back loans despite having the ability to do so, uses the funds advanced by banks for purposes other than the ones they were meant for, or disposes of pledged property or assets without the knowledge of creditors.
While RBI has not released data on the quantum of loans classified under the wilful default category, a bank union in Maharashtra released a list of wilful defaulters of loans over ₹ 1 crore on 1 January.
According to the list, such loans totalled ₹ 84,579.72 crore. The union’s general secretary Vishwas Utagi claimed the list had been prepared by RBI. Mint could not independently verify the claim.
Sebi’s discussion paper says wilful defaulters can’t sell shares, debt securities and non-convertible preference redeemable shares to the public. Such companies can still raise funds through a rights issue or a qualified institutional placement to institutional investors with full disclosure.
The paper also says wilful defaulters can’t take control of another listed entity, but that they will be allowed to participate in counter offers in case of hostile bids for taking control of a firm.
Each of these restrictions will be applicable if “the issuer, its promoter, group company or director of the issuer of such securities, is in the list of wilful defaulters published by the Reserve Bank of India," the stock market regulator added.
A banker said Sebi’s proposals, if implemented, would “be a huge positive for the banking sector" because banks can use them to put pressure on wilful defaulters.
“Tough measures are the need of the hour," added Ram Sangapure, executive director, Punjab National Bank. He said that banks have also suggested to the government that it allow criminal proceedings against wilful defaulters.
In its discussion paper, Sebi highlights the pros and cons of tightening regulations for wilful defaulters.
“The wilful defaulters do not have access to bank finance which means that the exposure of banks to such wilful defaulters is restricted. Along the same lines, exposure in the capital markets to such wilful defaulters may also be restricted," said Sebi, adding that such measures are expected to further enhance the protection of investors in the securities market.
Sebi also highlighted the downside of imposing such stringent restrictions on companies and promoters who are termed wilful defaulters.
“Restriction of access to capital market by way of rights issue may negatively impact the operations of the listed company, thereby negatively impacting its share price. Such a measure may not be in the interest of the shareholders of the listed company. Theoretically, the shareholders should infuse funds if the company is in trouble. Shutting down finance even from own shareholders appears to be unreasonable," said Sebi.
Balancing out these concerns, the capital market regulator has allowed wilful defaulters to raise funds from existing shareholders via a right issue, or from institutional investors through a qualified institutional placement.
“Existing listed companies/its promoter/group company/director of the Issuer categorized as ‘wilful defaulter’ may make a rights issue/private placement to qualified institutional buyers, with full disclosures in the offer document," said Sebi in the paper.
That seems fair, said an expert.
“From the proposed norms, it seems Sebi intends to prevent new investors from risking their money for wilful defaulters through public issues or takeovers," said Vidya Rajarao, partner, forensic services, Grant Thornton India Llp.
“Allowing wilful defaulters to launch rights issues, however, suggests that since the existing shareholders are likely to be aware of the company’s situation it may not be difficult for them to take a decision while subscribing to the rights issue and there is a possibility that the issuer, as a wilful defaulter, will offer shares at a much fairer price to the investors due to the need of capital."
Rajarao added that allowing wilful defaulters to participate in counter offers in the case of hostile bids will ensure that other entities don’t take advantage of the wilful defaulters’ condition and take over the latter’s assets at a price lower than the fair value.
The tougher stance taken by regulators comes against the backdrop of an increase in stressed assets across India’s banking sector. As of September 2014, stressed assets (which include bad loans and restructured assets) stood at 10.7% of the total loans in the system.
Much of this is due to regulatory hurdles—including those related to access to resources, land acquisition, or environmental clearances—but at least a part, according to RBI governor Rajan, is the result of a weakening credit culture. “The sanctity of the debt contract has been continuously eroded in India in recent years, not by small borrower but by the large borrower," Rajan said in the 25 November speech.
“It (the quantum of loans) is big, depending on what you call big, but I would doubt that it would extend into the lakhs of crore. I think it would be more in the tens of thousands of crore. That in itself is a big number, but it’s not the central number that’s responsible for the weakness in the banking sector in terms of stressed assets," Rajan said on 2 December in response to a question on the amount of loans stuck in the wilful default category.
Having someone declared a wilful defaulter isn’t easy.
For instance, banks are still struggling to declare Kingfisher Airlines Ltd, which owes banks ₹ 6,521 crore, a wilful defaulter. On 27 December, the Calcutta high court rejected state owned lender United Bank of India’s decision to tag directors at Kingfisher Airlines wilful defaulters.
“If used properly, Sebi’s new steps can be a great tool to curb the occurrence of wilful defaults, since borrowers will be very careful not to fall in that category. Say, if a parent company has been a guarantor for a wilful defaulter, then even the parent company can be brought under this ambit and their capital market activities can be curbed," said Nirmal Gangwal, founder and chief executive officer, Brescon Corporate Advisors, a debt restructuring advisory firm.
Gangwal, however, cautions that bankers must not use tough regulations against wilful defaulters as a way to intimidate borrowers. “... one thing we have seen is that at times, the wilful defaulter tag is used as an intimidation technique by bankers to avoid non-performing assets. This is against the spirit of business and should be strictly avoided," he said.
Some experts warn that the norms, if adopted, could ultimately prove counter-productive.
“It should be left to the investors whether they want to buy the securities of a particular company or not," said Sandeep Parekh, founder, Finsec Law Advisors, a Mumbai-based corporate law firm.
He added: “These norms, if implemented, will hurt the banks more because if the wilful defaulter is barred from the market it will not be able to pay off its dues to the bank."
Sebi is seeking comments from the public on the discussion paper till 23 January.
anirudh.l@livemint.com
Unlock a world of Benefits! From insightful newsletters to real-time stock tracking, breaking news and a personalized newsfeed – it's all here, just a click away! Login Now!
