Restructuring Project Finance Bank Debt in India: Information Asymmetry and Agency Costs

Abstract

Mounting non-performing assets (NPAs), particularly for project finance bank loans to public–private partnership (PPP) projects in the infrastructure sector, is a cause of concern for the Indian banking industry. In order to tackle the problem of NPAs, the Reserve Bank of India (RBI) advises banks on joint and corrective actions that include early detection of declines in asset quality, infusions of equity, conversion of debt into equity, fresh management commitments, and distressed sales of assets. This article presents a conceptual framework and suggests that in economies such as India’s, there is information asymmetry among the key stakeholders of PPP projects. This makes it difficult for banks to structure perfect deals or monitor loans after they have been made. Information asymmetry leads to agency costs for the project as sponsors’ actions are sometimes directed at shedding the risk to the banks and exiting the project. The data show that debt has increased and that the interest coverage ratio has declined for infrastructure companies in the last five years. The author calculates the new risk premiums that equity investors will demand as debt piles up in the balance sheets of infrastructure companies. Data from Moody's Investors Service are analyzed to consider the feasibility of distressed asset sales. The author argues for a simple solution: Policies for project finance debt restructuring should aim at, in addition to financial solutions, addressing the structural problems of information asymmetry and agency costs among the key stakeholders. This should lead to a solution for NPAs that is sustainable in the long run.

TOPICS: Fixed income and structured finance, other real assets, emerging, legal/regulatory/public policy