Economic Survey Series-2: Twin Balance Sheet Problem

Twin balance sheet problem and Indian Paradox

Twin balance sheet problem refers to the burden of over leveraged companies and bad loans of banks.

This happened in East Asia during 1997-1998 & US & EU in 2008-2009 but unlike these economies, India that is facing this TBS problems, is also growing at world beating pace.

Generally, Leverage of a company is inversely proportional to economic growth and so GDP growth should mean that our company should be under leveraged & this in turn means NPAs of banks should be less.

This is the Indian paradox: GDP is increasing, companies are over leveraged and NPA of banks are jumping.

Why TBS problem?

In general:

  • During boom corporate over expand, leaving them with obligations that they can’t repay.
  • They default, increasing banks NPAs.
  • This proves devastating for growth as effected corporates are less reluctant to invest and non-effected corporates are not in a position to invest, as banks are not in a position to lend.

Indian case

This does not happened to the extreme in India because:

  1. Indian companies and banks had avoided this boom period’s mistakes made by their counterpart abroad.
  2. Capital control by government prevented an undue recourse to foreign loans.
  3. Market demand was never too sluggish and hence except for a brief period, we registered fast GDP growth rate.
  4. Moreover, in India, TBS problem first emerged in 2010 that too mainly in PSU banks. Public Sector banks were backed by government & so creditors retained complete confidence in the banking system.

What went wrong in India?

  • In mid 2005, GDP growth surged to 9-10% per annum.
  • High profits of corporate , encouraged them to hire labor aggressively, which in turn sent wages soaring
  • Firm made plants’ expansion. This propelled Investment/GDP ratio to its highest point over 38% in 2007-2008 & non food bank credit doubled in just 3 years from 2004-2005 to 2008-2009.
  • Capital inflow also reached 9% of GDP.

To conclude we may say that companies were taking more risk.

Impact of this risk taking

High risk taken by companies, resulted in

  1. Increase in cost of production
  2. Financing cost increased because
  • RBI increased Repo Rate to the highest level to control inflation
  • Borrowing from abroad became costly with the rupee depreciation.

These results coupled with financial meltdown and subsequent international market collapse lowered the revenue of companies.

So higher costs, lower revenue and greater financing cost, squeezed corporate cash flow, leading to debt servicing problems.


It refers to debt & profitability ratio used to determine easiness with which a company can pay interest on outstanding debt, with its available earning.

ICR=EBIT/Interest Expense =Net earnings (before extraordinary items)-Equity Income

+ Minority interest in earnings of subsidiary companies

+All income taxes


Total interest charges.

Therefore lower ICR means more debt burden of the company

  • When company’s ICR is 1.5 or less. Companies’ ability to meet internal expenses may be questionable –So, company’s risk to default is high.
  • When company’s ICR is 1-Company’s risk to fall into bankruptcy is very high
  • When company’s ICR is =2.5, it is considered as Warning sign for Company

EBIT is sometimes replaced by

  1. EBITDA (Earnings before interest, tax, depreciation and amortization); or by
  2. EBIAT (Earnings before interest and after tax).



What explains the Twin Balance Sheet Syndrome with Indian Characteristics?

  • TBS problem followed the same path as in other countries like a surge of borrowing, leading to over leverage and debt servicing problem and bad loans.
  • But in case of consequences, TBS of India followed different path as compared to developed countries.
  1. Though Indian TBS problem caused structural damages but its impact on growth has been quite modest.
  2. TBS did not lead to stagnation in India as occurred in US, EU & Japan.

Why it has least impact on India?

  • During boom in India, investment was directed towards the capital scarce infrastructure while in USA it was diverted towards real estate. Investment in infrastructure like powers, roads etc. are still paying dividend and TBS problem had less negative impact on GDP.
  • In USA and other countries, TBS problem immediately triggered bankruptcies while in India Companies and banks were provided extended time for recovery. So in US bankruptcies brought down growth in the short run. We needed infrastructure development and so extended time or fresh funding to companies encouraged payment of loans, though at later period. However, due to these steps stressed asset far exceeded the headline figure of NPSs.

Is this strategy sustainable?

        Restructured/refinanced Companies will accelerate economic growth, this will gradually raise the cash flow of stressed companies, eventually allowing them to service their debts and hence TBS problems will gradually fade away.

However, this is possible only when economic growth accelerates.

What needs to be done?

RBI’s efforts

  1. Rescheduling of loans to give more time to stressed companies. Under 5/25 Refinancing of Infrastructure Scheme, lenders were allowed to extend amortization period to 25 years with interest rate adjusted every 5 years.
  2. Encouraged the establishment of ARCs under SARFESI ACT 2002. However, this step was not successful as ARC’s brought only 5% of total NPA’s of book value over 2014-2015 and 2015-2016.
  • SDR (Strategic Debt Restructuring) was introduced in June 2015 under which creditors could take over firms that were unable to pay and sell them to new owners.
  1. S4A (Sustainable Structuring of Stressed Assets) was announced in 2016, under which creditors could provide firms with debt reductions up to 50% in order to restore their financial viability. However result is not encouraging by the end of Dec 2016.only 2 dozens companies entered into negotiations under SDR & only 1 under S4A.
  2. RBI encouraged creditors to form forum, where decision can be taken by 75% of creditors by value and 60% by number. But reaching agreement is difficult as different banks have different degree of credit exposure, incentives etc. E.g. a bank with large exposure will be ready to bear large losses
  3. RBI emphasized ARQ (Asset Quality Review) to verify that banks were advancing loans in line with RBI’s loan classification rules.

Government’s effort:  Under Indradhanush scheme government promised to infuse rupees 70,000 Cr. of capital into the Public Sector banks by 2018-2019. But this is far from sufficient.


  • 2015-2016 Economic Survey stressed the need of 4 R’s (Reform, Recognition, Recapitalization and Resolution) to address TBS problems.
  • There was a suggestion to recapitalize banks through the Excess of capital of RBI:

RBI is one of the highly capitalized CB of the world. This is actually government’s excess capital with the RBI. This can be utilized in two ways:

  1. Recapitalize banks or capitalize PARA (Public Sector Asset Rehabilitation Agency) or
  2. Use it to eliminate Fiscal Deficit of government.

But it is opposed.

  1. Adequate buffer is needed to maintain high equity to net foreign assets ratio.
  2. Adequate buffer is needed to meet the likelihood of capital loses that may arise due rupee depreciation.
















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