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The Twin Balance Sheet Problem

Submitted to
Prof. S Shekhar Singh 1
Prof. Chander Mohan
Presented by

Harshit Goel – 748

Misha Ahuja – 754
Nikhil Taneja – 752
Saurabh Kumar Sharma – 751

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What is Twin Balance Sheet Problem?

A balance sheet is a statement of an

institution’s assets and liabilities.

But, the ‘twin balance sheet’ issue refers

to the problematic balance sheets of
Indian companies and banks 2

It Basically refers to the stress on

balance sheets of banks due to non-
performing assets (NPAs) or bad loans
on the one hand, and heavily indebted
corporate on the other.

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Why does Twin Balance Sheet Problem matters?

•For an economy to grow, its banks have to be stable and its

companies have to keep planning new investments and
projects.
•Currently, banks are not stable.
•Back in February 2016, banks reported that the amount of
bad loans exceeded the total interests they earned as 3
‘operating earnings’, the Economic Survey said.
•If depositors start withdrawing money, a bank could easily
shut.
•At such times, banks start lowering the amount of money it
lends. This means the new companies that want to execute
new projects or investments would not have access to
funding.
•Lower investments have been the key cause of India’s slow
economic growth in the past decade

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TBS is two two-fold problem for Indian economy which deals with

•Overleveraged companies – Debt accumulation on

companies is very high and thus they are unable to pay
interest payments on loans. Note: 40% of corporate debt is
owed by companies who are not earning enough to pay back 4
their interest payments. In technical terms, this means that
they have an interest coverage ratio less than 1.

•Bad loan encumbered banks – Non Performing Assets (NPA)

of the banks is 9% for the total banking system of India. It is
as high as 12.1% for Public Sector Banks. As companies fail to
pay back principal or interest, banks are also in trouble

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Origin of twin balance sheet problem in India
1. Origin of TBS problem can be traced to the 2000s when the economy was on an upward
trajectory.

2. During that time, the investment-GDP ratio had soared by 11% reaching over 38% in 2007-
08. Thus non-food bank credit doubled and capital inflows in 2007-08 reached 9% of GDP.
Due to such a boom in the economy, firms started taking risks and abandoned their
conservative debt/equity ratios and leveraged themselves up to take advantage of the
upcoming opportunities.

3. But Global Financial Crisis (2007-08) reduced growth rates and thus revenues from the
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investment. Projects that had been built around the assumption that growth would
continue at double digit levels were suddenly confronted with growth rates half that level.

4. Firms that borrowed domestically suffered when RBI increased interest rates to avoid
inflation increasing financial costs.

5. Environment and land clearances in infrastructure sector delayed the projects.

6. Thus higher cost, lower revenues, greater financial costs-all squeezed corporate cash
flow leading to NPAs in the banking sector.

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 Twin Balance Sheet Cycle

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Bank’s Irrational
Exuberance Economic Crisis

Corporate Debt Servicing 6

Expansion Failure (NPA
Creation)

Economic Boom Economic Downturn

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India’s Experience With TBS

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India’s experience with TBS vs Others’

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‘Give time to
Govt. Backed time’ strategy
PSB

Balance Sheet
Syndrome with
Indian charac
Infra dev Induced
demand Further funding
to stressed firms

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India’s experience with TBS vs Others’

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Such financial model can only be successful, if Dynamic Indian Economy carries the firms to
profitability

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“or”

Due to rapid growth of GDP, these loans will fade away as a small proportion of economy, even
if they aren’t profitable

A 40% drop in already insufficient

Companies has to borrow more, on ever
earnings increasing interest obligations
30000
10
25000
To bridge gap between cash flow and debt,
20000 companies sold off their assets
15000
10000 In long term, this crippled the firm with less
5000 income to service their debt
0
2012 2013 2014 2015 Q2 2015 Q4 2016 Q3 Aggregate financial position was in net loss of
EBIT (Crores) INR 15,000 Cr every quarter

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Power Sector

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Cost overrun by 50 % and more in all the installations

Merchant tariff = INR 2.5/kwh

Breakeven tariff = INR 4/kwh
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60 % of loans are stressed
category

Similar situation in MSMEs

and Telecom sector

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Negative loop of growth

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Decrease in new
investment
Twin Balance Sheet Twin Balance Sheet
problem Low growth
problem
No new loans by
stressed banks

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Worsening Health of Public Sector Banks

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40 % of stressed loans are
from 13 public sector banks

Negative ROA has affected

the bank share price
increase in margins means that performing borrowers and
MSMEs has been hit worst by

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depositors are effectively being taxed in order to subsidise the nonperforming borrowers.
negative loan growth
 What needs to be done

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Asset Strategic Debt Sustainable
Reconstruction Restructuring Structuring of All 3 programs met with limited success
Companies Stressed Assets

Multiple issues can be identified for such results

Lack of Proper
Loss Recognition Coordination Incentives Required Capital 14

it has now been eight years since the twin balance sheet problem first materialise. because the
financial position of the stressed debtors is deteriorating, the ultimate cost to the government
and society is rising not just financially, but also in terms of foregone economic growth and the
risks to future growth.

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Here market based mechanism isn’t working due to distorted incentives
 Centralized approach-Creation of PARA

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(Public Sector Asset Rehabilitation Agency)
• To be responsible for maximum recoveries within defined time
• Separation of loan resolution process from concerns about bank capital
• Many East Asian countries, facing TBS problem have already adopted asset rehabilitation agencies
How would PARA work?

Purchase specified loans Once the financial viability

from banks belonging to Once loans will be off the of the those firms is 15
over-indebted firms and books, govt. will restored, they will be able
converting from debt to recapitalize them by to focus on their
equity or by granting debt making new loans operations and consider
reduction new investments

• Price to be paid, accepting and paying for the losses, inevitable cost
• Govt must work on minimizing existing liability by resolving bad loan problem

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Sources of funding

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•Would increase debt stock but,
Govt issues •Could strengthen govt financial position
of securities

•Could help replenish the capital of the public sector banks if govt were 16
Capital willing to sell down its holdings
Markets

•RBI’s capital would decrease

•Capital of banks and PARA would increase
RBI •No implications for monetary policy, since no new money would be created

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Pain Points that must be realized

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• Readiness to confront the losses that have already occurred in the banking system; if defaulting
companies are taken over and sold, this could be seen as excessively strong government

• The PARA needs to follow commercial rather than political principles, which can be broadly within
the aegis of the public sector but with government owning 49 per cent

• If loans are transferred at inflated prices, banks would be transferring losses to the Rehabilitation 17
Agency. To get around this problem, market prices could be used, but establishing the market price
of distressed loans is difficult

These problems are not easy to deal with.

“Once you have eliminated the impossible, whatever remains, no matter how
difficult, must be the solution.”

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Conclusion

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Addressing the stressed asset problem would require

Reform
Recognition
Giving govt
ownership in of
public sector
banks
Bad assets
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Resolution
Recapitalization
What stake
Of banks
holders want

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