Four Balance Sheet Challenge Project

THE FOUR BALANCE SHEET CHALLENGE
The Four Balance Sheet Challenge
Ria Sewak(1)
, Lalramsiami Hrahsel(2)
, Ashly Anna Jaison(3)
Economics Department, St. Stephen’s College
Author Note
(1)
Ria Sewak: Second year, B.A (H) Economics, St. Stephen’s College
(2)
Lalramsiami Hrahsel: Second year, B.A (H) Economics, St. Stephen’s College
(3)
Ashly Anna Jaison: Second year, B.A (H) Economics, St. Stephen’s College

Serial No. Topic Page
1 Abstract 1
2 Investment Boom 2-4
3 Non-Banking Financial Companies Led credit Boom 4-5
4 Non-Banking Financial Companies Crisis 5-6
5 Fiscal policies that negatively affect the businesses 7-9
6 Economic Crisis and the Twin Balance Sheet Challenge 10-11
7 The Four Balance Sheet Crisis 11-12
8 NPA Restructuring 12-14
9 Conclusion 14-17
10 References 18

Abstract
A balance sheet is a financial statement that summarises an institution’s assets, liabilities and
shareholder’s equity at a specific point of a time.The Four Balance Sheet challenge includes the
sectors infrastructure companies ,banks,NBFCs and real estate companies.The roots of India's
Four balance sheet challenge can be traced back to the Twin balance sheet problem.This problem
was a result of India's over-leveraged companies and bad loan-saddled public sector banks.As the
years rolled by the “Twin Balance Sheet problem” morphed into a “four balance sheet
challenge”. We delve into the solutions that can be taken to solve these balance sheet problems of
intertwined sectors.
Keywords: Balance sheet, Credit, Crisis, Infrastructure, NBFCs

Investment Boom
Three years ago, the Indian economy clocked a quarterly growth rate of over 9 per cent. Now,
growth has slowed to nearly half that rate, printing at 4.7 per cent for the latest quarter
(October-December 2019). Most estimates place growth for the current fiscal year, ending March
2020, at 5 per cent, and for 2020-21 at 6 per cent. This is an astonishing slowdown for a country
that, until recently, enjoyed bragging rights as the fastest growing large economy in the world.
What explains this growth slump? Although there is a cyclical component, there is now
consensus that the problem, at its heart, is largely structural. To understand the structural causes
behind the slowdown, it is necessary at first to look back to the turn of the century, when an
extraordinary investment boom set India off on a remarkable growth trajectory.
An important consequence of India’s momentous economic reforms in 1991 — which lifted
controls on production and liberalised markets — was to unleash the huge reservoir of
entrepreneurship that remained pent up for decades. As the economy gradually but surely broke
out of the stranglehold of the proverbial “Hindu rate of growth”, entrepreneurs were hungrily
scouting for investment opportunities. Meanwhile, a significant, albeit silent, consequence of the
reforms was to remove the urban bias that had ruled economic management until then, and shift
the terms of trade toward the rural sector. Rural incomes went up, pushing up demand for
consumption goods, which in turn pushed up demand for investment.
As investment boomed, going up from 24 per cent of the GDP in 2000-01 to an unprecedented
high of 38 per cent by 2007-08, the Indian growth story started unfolding, with the economy

expanding at an average annual rate of over 7 per cent during the decade of 2001-10,
notwithstanding the global financial crisis. This country of over a billion people, it seemed, had
at long last discovered the holy grail to rapid growth, triggering tantalising speculation about it
being India’s turn to be the next growth miracle. That was not to be.
That boom is associated with a sharp upturn in the investment rate peaking at 38% of GDP in
2007-08, with rising domestic saving financing (most) of this investment. Unprecedented foreign
capital inflows – foreign direct investment (FDI), foreign portfolio investment (FPI) and external
commercial borrowings (ECBs) – at close to 10% of GDP supplemented domestic resources. A
rising share of short-term financial inflows caused concerns about financial fragility. However, as
the capital inflows were reportedly put to productive use, the criticisms against the inflows were
muted. The ‘Dream Run’ was also a debt-led growth with bank credit to the private corporate
sector (PCS) burgeoning at an unprecedented pace; a large share accrued to big business and
politically connected firms. These resources went into infrastructure projects such as roads,
ports, coal, and thermal power plants (Nagaraj, 2013). Public-private partnerships (PPP) was the
preferred mode of investment in infrastructure as the Government cut down on public investment
to adhere to fiscal orthodoxy in line with the Washington Consensus that was the guiding star of
economic policy.
Things started unravelling around 2010, when investments started crumbling, bad loans
mounted, and the financial sector came under stress. In popular perception, this was all a result

of crony capitalism. There may have been some of that, but there were several other — and
bigger — factors at play.
The net result of all these negative circumstances was that investment slowed and the structural
growth engine petered out after 2010, with growth being driven largely by consumption. It was
this economy, firing on a single engine, that Modi inherited when he first came in as Prime
Minister in the summer of 2014.
Non-Banking Financial Companies Led credit Boom
The Non-Banking Financial Companies (NBFCs) are quasi-banking institutions in India. They
are allowed to make loans just like banks do. However, they are not allowed to take deposits
from people in order to make these loans. Hence, these Non-Banking Financial Companies
(NBFCs) borrow money from the bond market in order to make loans. In India,despite being
different from banks, NBFC are bound by the Indian banking industry rules and regulations.
Their share of credit has increased because they were lending in sectors where banks refused to
go or did not want to go.
NBFCs have been in trouble since 2018. Traditionally retail as well as institutional borrowers in
the Indian market preferred to borrow from banks. However, of late, this has changed because of
the precarious financial situation that the banks find them in. The Indian banking sector was
already struggling with bad loans which have been made because of kickbacks and nepotism.
This is the reason why Non-Banking Financial Companies (NBFCs) performed better than banks
for the first time in 2017. However, in the second quarter of 2018, the Non-Banking Financial

Companies (NBFCs) seem to have come across a perfect storm. They are now at the epicenter of
a massive stock market crisis. The gross non-performing assets (NPAs) of NBFCs as of 31
March 2019 stood at 6.60%. This is the worst in a period of six years. This means a greater
proportion of loans given by NBFCs is not being repaid than in the past. As of 31 March 2018,
gross NPAs of non-bank lenders stood at 5.3%. This figure has jumped by 130 basis points
during the course of just a year. One basis point is one hundredth of a percentage point.
Non-Banking Financial Companies Crisis
Indian Non-Banking Financial Companies (NBFCs) have been playing a very risky game. They
have been borrowing money short term and have been lending it out long term. This asset
liability timing mismatch is obviously a recipe for disaster. However, the NBFCs have been able
to roll it over and pay their debts when due. This is the reason the Non-Banking Financial
Companies (NBFCs) were able to function without too many problems. For example, an NBFC
raises money by selling 6-month debt papers and on-lends this as a car loan with a tenure of 5
years. This leads to a situation where the NBFC has to roll over (or renew) the 6-month debt
paper or raise fresh loans to repay the debt paper. In good times, this happens as a matter of
course. But when times are tough, this cycle is broken.
Now that NBFCs are finding it difficult to raise money or having to pay a huge cost for doing
so, this will choke the flow of credit to the economy. It will hit the Ministry of Micro, Small and
Medium Enterprises (MSME) sector which is already suffering from the twin blows of
demonetisation and the goods and services tax. Mutual Funds also stands as a factor behind the

NBFC crisis. These Non-Banking Financial Companies (NBFCs) also heavily relied on funds
available from debt mutual funds. The problem is that the NBFCs have caused a market crash.
As a result, both retail and institutional investors have reduced the quantum of investments in
mutual funds. As a result, the supply of funds from there has died down as well. This has added
to the woes of the Non-Banking Financial Companies (NBFCs).A government-appointed panel
is now trying to recover the money by selling assets of the group. However, this will not be easy.
An integral part of the NBFC crisis would be the debt issue the IL&FS has found itself in.
IL&FS was set up in 1987 when a consortium of banks decided that there was an urgent need for
a financing institution in the infrastructure space that could double down as a technical
consultant as well. In a bid to fund and profiteer from the infrastructure boom of the 90's, IL&FS
grew to be one of the prominent players in the financing industry with powerful backing from a
rich set of institutional shareholders. Over the subsequent decades, the company morphed and
evolved into a gargantuan behemoth with over 300 group companies. With a
slower-than-expected growth in the Indian economy, stalled projects and payment delays to the
firm, the financier had to rely increasingly on debt funding until the burden ballooned to over
90,000 crores at which point, IL&FS was proving to be a major liability to the financing
industry.The problem started due to mismanagement of funds. As a result, it is now not able to
pay back its creditors. The end result is that IL&FS stands exposed, and so does this faulty
business model of the NBFCs. Since the IL&FS panic has scared the investors away, the
Non-Banking Financial Companies (NBFCs) are not able to issue new debt in order to roll over
the old debt.

Fiscal policies that negatively affect the businesses
A supply shock is an unexpected event that suddenly changes the supply of a product or
commodity, resulting in an unforeseen change in price. Supply shocks can be negative, resulting
in a decreased supply, or positive, yielding an increased supply,however, they're often negative.
Assuming aggregate demand is unchanged, a negative supply shock causes a product's price to
spike upward, while a positive supply shock decreases the price.The impact of a supply shock is
unique to each specific event, although consumers are typically the most affected.
On November 8, 2016 the Indian government announced a dramatic policy measure:
“demonetization,” that is withdrawal from circulation, of the two highest denomination bills, the
Rs. 1000 and Rs. 500 bills, then constituting about 86% of the currency in circulation. Holders of
those bills had until year end to turn in the bills. The move was targeted at curbing “black
money,” money that is generated from illegal activity or from activity that is legal but has evaded
taxes.Demonetization has resulted in a supply shock.The ban on old notes is being cited as one of
the key contributors to the economic slowdown. With the gross domestic product (GDP) for the
April-June quarter slipping to 5.7%, the reality of the economic slowdown could not be
ignored.Demonetization led to a contraction of 2 percentage point in 2016 and a simultaneous 2
percentage point contraction for bank credit, with both effects dissipating over the next few
months.Various medium and small enterprises turned towards digitalization, however, the micro
industries were affected by the worst of its wrath. The micro industry owners were not a part of
the black economy and they were clearly unprepared for the effects of demonetization. Many

micro industry workers returned back to villages and the growth rate of these companies went as
low as 1%. In the short term, demonetization affected the economy adversely.
The introduction of the GST or the Goods and Services Tax on a nationwide basis has also led to
an economic slow down.Goods and Services Tax is levied on the manufacturing and sales of
goods and services across the country. The tax is charged at every stage of the manufacturing
process.
Indeed, GST has hampered the small businesses more than Demonetization.
It can be said that the implementation of GST is also flawed thereby exacerbating some of the
factors that have contributed to the slowdown.The union government’s gross tax revenue (before
giving out the states’ share) dropped from 11.2% in 2016-17 to 10.9% in 2018-19.Both these
measures has affected the Indian economy negatively.

Economic Crisis and the Twin Balance Sheet Challenge
Financial economic crises can be defined as the loss in financial assets, very quickly and sharply.
Rudy Dornbush says “Crisis takes longer than you think and happens much faster than you
would have thought.” This statement provides a deeper insight into the speed of the loss in assets
and this suddenness is the essence of the term “crisis”.
The financial assets involved are currency, real estate, equity etc. The cost of these crises has a
wide span, it includes repercussions like loss of income, high inflation, unemployment, Banking
crisis and contagion arising from open economies.
These crises lead to a twin balance sheet problem which has much to do with the banking sector
and the corporate sector of a country. Essentially the corporates face stress and in turn stress the
banks and majorly the public sector banks.
Why and how does the twin balance sheet problem arise, with reference to india?
To explain this, we need to look at the early 2000s when there was a boom in the economy and
India saw a growth rate of 8%. The private sector was booming and invested heavily in
infrastructure. This boom was financed by rapid credit growth by domestic banks and a rapid
increase in foreign flows. The spendings were undertaken by private sector firms which were
funded by the public sector banks. These boom periods lead to irrational investment due to high
growth rates which can be termed as ‘irrational exuberance’ from the investors perspective. The
firms and banks both started taking higher risks due to high investment and high growth rates.
The debts rose higher. During that time, the rupee value went down and all the firms that had got
foreign lending, became stressed due to the increase in debt in terms of dollars. The companies

couldn't repay their debts due to higher costs, lower revenues and greater financing costs turning
into a non performing asset for the public sector, which affected their balance sheet and caused
an increase in lending rates, causing a cycle of non payment of high debts and losses to banks .
Effect of NPA for banks is multifold, it affects the profitability, credit creation, provisioning, and
liquidity of banks. Profit in the balance sheet of the banks reduces as the interest and the
principal amount is not recovered, over and above banks need to additionally provide over 25%
for these non performing assets leading to a loss in not only the income but also further lending
and liability creation. Banks are forced to increase the lending rates and reduce deposit rates to
make up for loss in income. Banks eventually lend less to maintain their risk to capital ratio. As
per extant guidelines, banks whose Net NPA level is 5% & above are required to take prior
permission from RBI to declare dividend and also stipulate cap on dividend payout which causes
shaky confidence of the public and shareholders.
The Four Balance Sheet Crisis
The four balance sheet challenge is an extension of the twin balance sheet challenge. The four
balance sheet challenge was given rise by the collapse of a credit boom led by NBFCs and the
real estate sector. This affected four balance sheets, first of the private investment firms, second
of the banks, third of the NBFCs and fourth of the real estate companies. The stress on these four
components of the economy owed to the recognition that the boom involved unsustainable
financing of a rising inventory and unsold houses.

India presently faces the four balance sheet challenge as pointed out by Arvind Subrimanian and
Felman in their latest paper titled “India’s Great Slowdown: What happened? What's the way
out?"
The increase in NPAs caused the banks to become more cautious while lending, increase in
lending rates and stringent RBI rules. When the banks refrained from lending to contain the
NPAs, NBFCs became major lenders. This credit flow again boosted the investment and private
consumption. The infrastructure leasing and financial services (IL&FS), a non-banking financial
company lending infrastructure projects failed in september 2018. IL&FS failed due to liquidity
crunch, new projects could not take off and running projects faced high costs. This had a trickle
down effect on the entire financial system. The banks faced more NPAs and could not stimulate
credit creation, contracting the process further. NBFCs were also now facing stressed balance
sheets. The real estate sector was down because most of NBFC lending was in the real estate
sector and real estate itself was facing a slow down. Real estate is facing a low demand due to
which builders are not able to repay debts causing real estate to join the balance sheet stress.
NPA Restructuring
A Non-Performing Asset is a loan or advance for which the principal or interest payment
remained overdue for a period of 90 days. Non-Performing Assets is an alarming challenge in
India. The Non-Performing Asset distribution in the Indian banking system follows the 80-20
rule; 20% of borrowers are responsible for 80% value of the impaired assets and vice versa.
The Reserve Bank of India (RBI) report revealed that Indian banks have the highest number of
NPAs as compared to 10 emerging economies including China, Turkey, Philippines, Brazil and

Indonesia. It confirmed that 9.1% of the total advances (Rs 9.36 lakh crore) turned into NPAs in
2018-19. It further pointed to the low percentages of NPA, 1.8% in China and 4% in Turkey, to
draw a comparison with India’s increasing number of NPAs.NPAs story is not new in India and
there have been several steps taken by the GOI on legal, financial, policy level reforms. In the
year 1991, Narsimarao committee recommended many reforms to tackle NPAs.
Several measures have been taken by the Government of India and the Reserve Bank of India the
past many years to tackle the problem of NPAs but the recent measure taken was that the Reserve
Bank of India released fresh guidelines in 2019 to deal with bad loans after the Supreme Court
quashed its 12 February 2018, a circular which mandated lenders to start resolution even if there
was a one-day default. New NPA resolution norms replace all the previous models, the central
bank said. Under the new norms, defaults are to be recognized within 30 days, says RBI. The
circular was struck down by the Supreme Court of India in April after several companies had
challenged the guidelines in court arguing the time given by the central bank was insufficient to
tackle bad debt.
Some of the fundamental principles underlying the regulatory approach for resolution of stressed
assets are as under:
● All lenders must put in place board-approved policies for resolution of stressed assets.
● It is expected that the lenders initiate the process of implementing a resolution plan (RP)
even before a default.
● Lenders shall report credit information on all borrowers having aggregate exposure of Rs
5 crore and above them.

● In cases where RP is to be implemented, all lenders shall enter into an inter-creditor
agreement (ICA)
● They shall submit weekly reports of instances of default by all borrowers with aggregate
exposure of Rs 5 crore and above.
● ICA to provide rules for finalization, implementation of RP for those with credit facilities
from more than one lender.
RBI said intent to evergreen stressed accounts by lenders will be subjected to stringent actions
including higher provisioning & monetary penalties.According to the revised guidelines, extant
instructions on strategic debt restructuring scheme, change in ownership outside SDR are also
withdrawn and so are the extant instructions on scheme for sustainable structuring of stressed
assets.
The framework is not available to borrowers to whom specific instructions have already been
issued for initiation of insolvency proceedings under IBC.
RBI said borrowers who have committed frauds/malfeasance/willful default will remain
ineligible for restructuring.
Conclusion
India has taken various steps to tackle the twin balance sheet problem-
Refinancing of Infrastructure Scheme: This scheme offered a larger window for the revival of
stressed assets in the infrastructure sector and eight core industry sectors.Under this scheme,
lenders were allowed to extend amortisation periods to 25 years with interest rates adjusted every
5 years, so as to match the funding period with the long gestation and productive life of these

projects. The scheme thus aimed to improve the credit profile and liquidity position of
borrowers, while allowing banks to treat these loans as standard in their balance sheets, reducing
provisioning costs.
Issues faced with the scheme: However, with amortisation spread out over a longer period, this
arrangement also meant that the companies faced a higher interest burden, which they found
difficult to repay, forcing banks to extend additional loans (‘evergreening’). This, in turn, has
aggravated the initial problem.
Private Asset Reconstruction Companies (ARCs): ARCs acquire NPAs from banks or financial
institutions and try to resolve them.
ARCs are a product of and derive their asset resolution powers from the SARFAESI Act.
The issue faced: ARCs have found it difficult to recover much from the debtors. Thus they have
only been able to offer low prices to banks, prices which banks have found it difficult to accept.
The Strategic Debt Restructuring (SDR) scheme: The SDR scheme was introduced in June 2015,
under which banks could take over firms that were unable to pay and sell them to new owners.
The issue faced: By December 2016, only two sales have been materialised as many firms
remained financially unviable.
Asset Quality Review (AQR): The RBI emphasised AQR, to verify that banks were assessing
loans in line with RBI loan classification rules. Any deviations from such rules were to be
rectified by March 2016.
The Scheme for Sustainable Structuring of Stressed Assets (S4A): An independent agency hired
by the banks will decide on how much of the stressed debt of a company is sustainable. The rest
(unsustainable) will be converted into equity and preference share.

The issue faced: Only one case has been solved under this scheme so far.
The above measures fail to solve the Twin balance sheet challenge due to the following reasons:
● Loss recognition: Banks do not recognise stressed assets and continue giving loans. They
are reluctant to conduct the asset quality review for their assets.
● Coordination problems: Difficulty in deciding compensation by different banks on Joint
Lenders Forums which has not achieved much success.
● Court cases: Public Sector Banks are reluctant to write down loans as bank managers are
afraid of accusation of favouritism.
● Lack of Capital: Indradhanush Scheme promised to infuse Rs 70,000 crore into Public
Sector Banks by 2018-19. But this amount is not enough and banks need atleastRs 1.8
lakh crore more.
India has till now pursued a decentralised approach where individual banks have taken decisions
on its own to resolve NPAs. This approach has not resolved the problem and time have now
come to create a centralised agency called Public Sector Asset Rehabilitation Agency
(PARA).Twin Balance Sheet Problem (TBS) is a major problem that Indian economy is facing
today. There is no point of delaying this problem because the delay is very costly for the
economy as impaired banks are scaling back their credit while the stressed companies are cutting
their investments. The time has come to adopt the strategy that East Asia adopted during their
crisis period. The centralised agency in the form of PARA would allow debt problems to be
worked out quickly. The time has come for India to consider the same approach.
As a solution to the Four Balance Sheet problem, Subramanian and Felman suggested the
following measures -

● Launch a new asset quality review to cover banks and NBFCs (Recognition)
● Make changes to the IBC to better align incentives (Resolution)
● Create two executive-led public sector asset restructuring companies (“bad banks”), one
each for the real estate and power sectors (Resolution)
● Strengthen oversight, especially of NBFCs (Regulation)
● Link recapitalization to resolution (Recapitalization)
● Shrink public sector banking (Reform)

References
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out?.
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challenge, ET Online. Retrieved from https://economictimes.indiatimes.com
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Sharma,Rahul.THE TWIN BALANCE SHEET PROBLEM;HOW CAN INDIAN ECONOMY
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IMPACT OF DEMONETISATION ON INDIAN ECONOMY: A CRITICAL STUDY(2018,May)
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Livemint(2019, May 07). The ripple effect of the NBFC crisis on the economy
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1557242882381.html
India’s non- performing assets: A lurking crisis.(2014, April 1)
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Economic Times, (2018, Oct 03) IL&FS: The crisis that has India in panic mode.
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article30974625.ece

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