As Rajan tightens screws, Indian banks can still disguise bad debts

A tool provided by India's central bank to help lenders tackle bad debts is instead helping to camouflage the scale of the problem, evidence of how the country's banks will struggle to meet an ambitious clean-up target in 16 months' time.

India's banks are grappling with more than $110 billion of corporate stressed debt, a burden that is holding back fresh loans and hampering a speedier economic recovery.

Hoping to press banks to acknowledge the size of bad debts and tackle them, the Reserve Bank of India last week set a March 2017 goal, although it did not specify exactly what would have to be achieved by that date.

Emphasising the challenge ahead for governor Raghuram Rajan is the growing debate around the most high profile tool the RBI has offered lenders to date - strategic debt restructuring (SDR), a provision aimed at helping banks swap unpaid debt for majority control.

Rajan has campaigned to get banks to classify debt correctly, and to oust errant company owners. Commercial banks say his team has been active, checking provisions and exactly how loans are recorded and reported.

Yet while banks, including India's largest, have taken advantage of the benefits of SDR, none have yet used it to effectively tackle the underlying problems.

Crucially, SDR allows debt in the process to be classed as "standard", without extra provisions or writedowns, for 18 months. But without other changes, that may create trouble down the line, analysts warn.

"As banks through SDR are able to delay provisions on the stressed SDR accounts by 18 months, it would result in bunched up provisioning," Credit Suisse analysts said in a note, adding this could add to banks' already elevated credit costs.

So far, since SDR was introduced in June, it has been invoked by banks in nine cases, with at least one other due. Most are steel, resources and infrastructure firms.

In total, according to brokerage Religare, known SDR debts amount to some 641 billion rupees ($9.6 billion), or about 1 percent of all loans.

But none of these cases have seen banks swap debt for equity, take control or significantly cut debt.

The RBI says it will not tolerate misuse of an option intended to help turn around companies with potential. "It is not a concession to banks. If we find the banks are not playing by the rules we will deal with them," an RBI spokeswoman said in response to Reuters queries.

She added the central bank could step in even before 18 months if banks are found to be building "a huge book of such shares".