May 09, 2018

Twin Balance Sheet Problem in India - Indian Economy for UPSC & RBI Grade B

Indian economy for UPSC and RBI grade B officers exam

Twin Balance Sheet Problem in India - Indian Economy for UPSC & RBI Grade B

Twin balance sheet problem

It is shortly known as TBS problem. This twin balance sheet challenge is mentioned in economic survey 2017-18.

What is a balance sheet?

A balance sheet is a financial statement that summarises a company / Institutions assets, liabilities and shareholders equity at a specific point of time.

Twin balance sheet problem of India

Twin balance sheet deals with two balance sheet problems. One with the Indian companies and another with the Indian banks. It is the stress on balance sheets of both the lenders, that is the banks and the borrowers, that is the corporate.

Twin balance sheet problem refers to the stress on balance sheets of banks due to non performing assets or bad loans on the one hand and heavily inducted cooperates on the other.

This issue is important because it is holding a private investment in the country and therefore, growth in all sorts of sectors.

Twin balance sheet is a twofold problem for Indian economy which deals with over leveraged companies and bad loan encumbered banks.

1. Over leveraged companies

These or otherwise known as the companies having taken on too much debt. Under this problem, the debt taken by the companies is very high and they are unable to pay interest payments on loans.

2. Bad loan encumbered banks

Non performing Assets of the banks is 9% of the total banking system of India. It is as high as 12.1% for public sector banks. As the companies fail to pay back principal or interest, banks are also in trouble.

The Reserve Bank of India expects bad loans to raise to 10.2% of the total loans by March 2018. Currently, bad loans amount to 9.6% of the total loans as of March 2017. And if stress levels increase, bad loans could even raise to 11.2% by March 2018.

What's Wrong with the company balance sheet

Companies have too much debt and little money to repay. As per the economic survey 2016 to 17 it was reported that around 40% of the corporate debt it monitored was made by companies which had an interest coverage ratio less than 1. The interest coverage ratio compares the loan interest payments with the operating profits. If the company can repay its loan interest using the profits returns from its core business. If the figure is less than 1, it means the company's operations do not generate enough money to even repay the interest, let alone the entire amount.

Banks

A bank's key source of profit is the interest it earns on loans. If a company fails to pay back interest on the loan, the bank loses its profit. Not only that, the bank also loses the money is give out as the loan. As per the data with the RBI, in the Indian banking system, 9.5% of the total loans turned out to be bad loans. More than four fifths of the non performing assets were in public sector banks, where the NPA ratio has reached almost 12%.

How this had started?

During the 2000s the economy was moving forward, causing the investment GDP ratio to increase over 38% in 2007 to 2008. As a result the non Food bank credit doubled. Due to this increase in the economy, the company started taking risks to utilise the upcoming opportunities. But because of the global financial crisis 2007 to 2008, the growth rates were reduced and also the revenues from the Investments. The projects that were started with an idea of growth and profit was stopped. During that period RBI increased the interest rates to avoid inflation. Because of this step of The Reserve Bank of India the companies had to suffer and the projects got delayed.
This is why the higher cost, lower revenues, greater financial cost, all stopped the corporate cash flow leading to the non performing assets in the banking sector.

In India the problem of the Twin balance sheet first emerged in 2010.

Why does this matter?

For an economy to grow, its banks have to be stable. Also it's companies have to keep planning new investments and projects. Without this there would be no growth. Banks are not stable because the banks reported that the amount of bad loans exceeded the total interest earned as operating earnings. This makes the banks risky. When the general public start the withdraw their money from the bank, it may lead to shutting down of the bank. With this fear in mind, banks will reduce the money it lends. When the banks started to reduce the money that it lends, the new companies cannot execute new projects or Investments. This is the main reason for India slow economic growth.

Twin balance sheet problem in the economic survey 2017-18

The problem of Twin balance sheet in India is mentioned and discussed in the economic survey 2017-18. This problem was decisively addressed by sending the major stressed companies for resolution under the new Indian bankruptcy code and implementing a major recapitalisation package to strengthen the public sector banks.

The Economic Survey called for a need to set up a government owned asset reconstruction company PARA (public sector asset rehabilitation agency) in an attempt to solve India's twin balance sheet problem - over leveraged companies and the rising bad loans in public sector banks. The Economic Survey said that the agency could take charge of the largest, most difficult cases, and make politically tough decisions to reduce debt.

Advocating the public sector asset rehabilitation agency to resolve the problem of Twin balance sheets of corporates and banks to be funded by the gain to the government from the unreturned old demonetised notes. So for the public discussion of the bad loan problem had focused on Bank capital, under the assumption that the main obstacle to resolving the Twin balance sheet concerned was finding the funds needed by the public sector banks.

As per the economic survey, during funding is actually the easiest part, as the cost is small relative to the resources the government commands. Fomo problematic is finding a way to resolve the bad debts in the first place.

Since other approaches to resolve the Twin balance sheet problem had failed or had Limited success, the Economic Survey noted that the international experience shows that a professionally Run Central agency with government backing can overcome the difficulties that have impeded progress.

The Twin balance sheet problem is a serious drag on credit growth. The setting up of a centrally assisted rehabilitation agency will help in taking difficult decisions which the public sector banks are unable to take. Over the past few years non performing Assets of the public sector banks have been racing and is a cause for concern warranting lost right down. The Rehab agency could provide a compromise or mediation.

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