The aftermath of global economic recession saw falling corporate groups in the country with a severe bad debt crisis and taking banks especially the public sector banks saddled with non-performing assets, down with them. We need not panic and call it India’s sub-prime crisis just yet. But in the hindsight of global economic crisis and the subsequent lessons should teach us to be cautious rather than looking back for the causes and reasons when it’s all over. It is important for the policymakers to take timely regulatory steps before the fire spreads in the banking and financial system. The nature of the debt crisis and the extent of the bad corporate debt can be gauged from the fact whether the firms were financially healthy enough to take the loan and the amount of bank loans taken in a particular year.
There are two types of firms – healthy and unhealthy firms. The health of a firm can be measured by the Interest Coverage Ratio which is a ratio of net profits to interest payments. If a person is not able to pay in full the interest accrued, then the debt would keep piling up. The U.S. sub-prime crisis of 2008 was contributed to the fact that loans were given to sub-prime households incapable of servicing even the interest of the loan repayment. What held true for the household sector then in U.S. could be true for the corporate sector in India now. Significantly, unhealthy firms are able to not only excerpt fresh borrowing from the banks but increase it as well. The other measures are profitability, current ratio and debt to equity ratio. While the banks are also responsible for putting themselves in the current situation, the real culprits are the big borrowers and promoters who renege on loan repayments.