Blue-chip companies are considered the backbone of the economy—large, financially stable, and historically reliable. But what happens when one of these giants fails?
What are Blue Chip companies?
A blue-chip company is a well-established, financially sound corporation with a history of stable earnings and strong market capitalization.
A few typical examples in India include Reliance Industries, TCS, and HDFC Bank.
When such a company fails, it sends shockwaves through the financial system, particularly affecting banks that have lent money to or invested in the company.
How Banks Are Exposed to Blue-Chip Failures
1. Loan Defaults
Banks often provide large loans to blue-chip companies due to their perceived stability. If the company defaults, banks face non-performing assets (NPAs), hurting their balance sheets.
Example: If a blue-chip company like Tata Steel defaults on a ₹10,000 crore loan, the lending bank must classify this as an NPA, reducing its profitability.
2. Investment Losses
Banks may hold equity or bonds of blue-chip companies in their investment portfolios. A collapse leads to a sharp decline in asset value.
Example: If Yes Bank held bonds of a failing blue-chip, their market value would plummet, eroding the bank’s capital.
3. Contagion Risk
A blue-chip failure can trigger panic, leading to a broader sell-off in the stock market. Banks with exposure to other firms in the same sector may face secondary losses.
4. Collateral Damage
Banks often accept shares of the borrowing company as collateral. If the stock crashes, the collateral’s value diminishes, increasing the bank’s risk.
5. Higher Provisions:
RBI mandates banks to set aside higher provisions for NPAs, reducing available capital for lending. When banks can lend less, it directly impacts their future earnings.
6. Credit Crunch:
Considering that the banks may feel the heat of this failure, banks may become risk-averse, tightening loans to other businesses, slowing the overall economic growth.
Indian Tax Rules Related to Bank Losses
Banks are themselves subject to tax laws during such periods of distress, like the ones below:
1. Bad Debt Write-offsBanks can claim tax deductions on bad debts written off under Section 36(1)(vii) of the Income Tax Act. Conditions apply, such as the debt being recognized as irrecoverable.
2. Capital Gains on Asset Sales
If a bank sells distressed assets (e.g., collateral) at a loss, it can offset capital gains with these losses.
3. Provisions for NPAs
Tax deductions are allowed only for specific provisions (e.g., under RBI guidelines). General provisions are not deductible.
Example Case: IL&FS Crisis (2018)
What Happened?
Infrastructure Leasing & Financial Services (IL&FS), a blue-chip NBFC, defaulted on ₹90,000 crore in debt.
Bank Impact:
Public sector banks like SBI and PNB faced massive NPAs.
RBI intervened, forcing banks to increase provisions, hurting profits.
Credit markets froze, affecting liquidity for other corporates.
Summary
Nothing in a giant economy works in isolation.
The failure of a blue-chip company can destabilize banks through loan defaults, investment losses, and systemic risks.
While regulatory safeguards exist, the aftermath often includes tighter credit conditions and economic slowdowns.
Investors and depositors should monitor banks’ exposure to large corporates to assess risk.
Reference Links
Book: The Autobiography of a Stock
Blogpost: What are Large, Mid and Small-Cap Funds
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