Our GM, Orbelina Valeriano, is in Executive Management Training at INCAE (originally Harvard-related) in Managua, Nicaragua. Her class has been doing some case studies. This week it concerned the failure of some well known MFI's in the region despite showing improvement in balance sheet equity.
One financial transaction that is not usually highlighted is moving loans from the Liability Section of the Balance Sheet to Equity. Here's how it could happen. The institution borrows $1.0M from a foreign fund or similar with a 5-year payback. At the end of 5 years, the debt should be repaid, or if there is not enough cash, the company and the lender may opt to covert the debt to equity in the company. Instantly your $1.0M debt obligation on the liability side of the balance sheet becomes an increase of $1.0M in equity.
No new cash has entered the company to be used productively in operations. However, your balance sheet shows more equity and mostly will continue to attract other lenders who are looking for good potential borrowers The original lender didn't get back his/her funds, but there is always the possibility that the new shares will have more value in the future. You don't have to write-down or claim a defaulted loan right away and book a big lost on your P&L.
This is what happened with a big MFI in Central America. However, the scheme didn't last long as auditors finally caught on to what happened. The original investors were really leary of putting more money into a bad situation and opted to try this type of financial transaction. The odd thing about it - it's not illegal. Just be aware.