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Bad bank a bad idea? Five reasons why India needs a durable solution on NPAs

One of the proposals to resolve the NPA crisis is setting up of a “bad bank” that will absorb all the bad loans of commercial banks and cleanse the banking system.

business Updated: May 31, 2017 16:47 IST
Raj Kumar Ray
Finance Minister Arun Jaitley (L) and Reserve Bank Governor Urjit Patel at the RBI Board Meeting in New Delhi.
Finance Minister Arun Jaitley (L) and Reserve Bank Governor Urjit Patel at the RBI Board Meeting in New Delhi.(Mohd Zakir/HT PHOTO)

India’s banking system is passing through a critical phase as lenders are saddled with about Rs 10 lakh crore worth of stressed assets, loan growth is stuttering at near six decades-low levels and lending rates are still stubbornly high.

Standard and Poor’s warned on Tuesday Indian banks’ stressed assets are likely to rise to 15% of total loans by March 2018, and their credit profiles are unlikely to improve over the next 12 months.

The finance ministry and Reserve Bank of India are trying their best to salvage banks from the menace of NPAs.

One of the proposals to resolve the crisis is setting up of a “bad bank” that will absorb all the bad loans of commercial banks and cleanse the banking system. The “bad bank” idea is not a new concept to India. It has been tried with some financial institutions in some form or the other, but the end result has been that taxpayers’ good money is wasted in banks’ bad assets.

This time around, the government’s chief economic adviser Arvind Subramanian and Reserve Bank of India’s deputy governor Viral Acharya are pushing the idea of a bad bank. Acharya even proposed the twin concepts of a Private Asset Management Company (PAMC) and National Asset Management Company (NAMC) for resolution of stressed assets of the private and state-owned lenders, respectively.

However, NITI Aayog vice chairman Arvind Panagariya is averse to the idea.

Here are five things that have to be considered before setting up a bad bank:

1.Bad bank legacy

Bad bank concept was tried with the setting up of Industrial Reconstruction Corporation of India in 1971, for the rehabilitation of sick industrial undertakings.

It was later rechristened to Industrial Reconstruction Bank of India (IIBI) in 1985, and tasked to buy bad loans of commercial banks and recover the debt.

But absence of stringent recovery laws made IIBI sick. Between 2004-05 and 2005-06, the government paid close to Rs 263 crore to IIBI as grants so that it can service its debt.

There was also a proposal to merge IIBI and another other institutions IFCI and IDBI, but it was rejected. Finally, IIBI’s closure was announced in the Budget 2012.

IFCI and IDBI have also survived on periodic bailouts from the government.

In 2002, the government announced a Rs 400-crore life-line for IFCI and asked LIC, IDBI and SBI to provide Rs 200 crore each.

There was a proposal of segregating IFCI’s NPAs into a “bad bank” and finding a strategic partner for the “good bank”. But it did not materialise.

In 2004, IDBI was handed out a Rs 9,000-crore bailout package for shifting its bad loans into a separate Stressed Asset Stabilisation Fund (SASF), which in a way was a “bad bank”.

A decade later, the Comptroller and Auditor General of India in its report in 2014 criticised the government over the IDBI bailout saying: “This arrangement of transferring NPAs to the (SASF) Trust was akin to underwriting the non-performing assets of IDBI ... Thus effectively, Government of India has taken the burden of NPAs of IDBI by creating a future liability.”

2.NPA scenario

In December, RBI’s financial stability report said the gross non-performing advances (GNPAs) ratio of all banks increased to 9.1% by September 2016 from 7.8% in March 2016.

Stressed loans (non-performing as well as restructured loans) were up at 12.3% of total loan given out by banks by September, up from 11.5% in March 2016.

RBI’s stress test of the banking sector indicated that GNPA ratio may increase from 9.1% in September 2016 to 9.8% by March 2017, and further to 10.1% by March 2018.

PSU banks are worst hit as their GNPA may increase to 12.5% by March 2017 and then to 12.9% in March 2018, from 11.8% in September 2016.

While the government has pledged to infuse Rs 70,000 crore into its PSU banks over 2016-2019-- Rs 10,000 crore each during 2017-18 and 2018-19, analysts doubt the amount will be sufficient.

“In our view, these amounts will not be sufficient to fully resolve the public sector banks’ looming capital shortfall,” S&P said in its latest report.

3.Why NPAs keep piling up

The government has over the years enacted and tweaked stringent rules to recover assets of defaulters.

The Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act or Sarfaesi Act of 2002 was amended in 2016 as it took banks years to recover the assets.

Experts have pointed out that the NPA problem has to be tackled before the time a company starts defaulting. This needs a risk assessment by the lenders and red-flagging the early signs of a possible default.

RBI has also come up with loan restructuring schemes in the past few decades such as the corporate debt restructuring (CDR), formation of joint lenders’ forum (JLF), flexible structuring for long-term project loans to infrastructure (or 5/25 Scheme), strategic debt restructuring (SDR) scheme and sustainable structuring of stressed assets (S4A) to check the menace of NPAs.

In many cases, the companies have failed to make profits and defaulted even after their loans were restructured.

Lack of stringent rules including for quick liquidation and lengthy legal process have staggered the NPA cases.

4.Why a bad bank is needed now

The Economic Survey for 2016-17 pointed to a “twin balance sheet” (TBS) problem of overleveraged, or highly indebted, companies and bad loan encumbered banks, which it says is a legacy of the boom years before the global financial crisis of 2008.

Subramanian wrote in the Survey that it was time to consider a different approach to tackle the NPA problem by setting up a centralised Public Sector Asset Rehabilitation Agency (PARA) that could take charge of the largest, most difficult cases, and make politically tough decisions to reduce debt.

Since, private run Asset Reconstruction Companies (ARCs) have not been successful either in resolving bad debts, though international experience, especially that of East Asian economies, shows that a professionally run central agency with the government backing could overcome the coordination and political issues that have impeded progress over the past eight years.

Without a bad bank, the Survey said recapitalization of NPA-laden banks increases the costs to the government as well as the costs to the economy, by hindering credit, investment, and therefore economic growth.

5.The other options

The implementation of Bankruptcy Code and the recent amendment to the Banking Regulation Act may help in tightening NPA rules and ensure quick recovery of debt.

The amendment in the banking law gives extra powers to the RBI to empower a panel (oversight committee) to monitor the progress of steps against big defaulters.

Many of the NPA cases can be traced to delay in clearances for land, environment and licences.

According to Centre for Monitoring Indian Economy, the proportion of stalled private sector projects rose to a 52-quarter high of 20.2% in the March quarter. This has locked up lakhs of crore of private investment and bank funds.

Unless the Centre and states speed up clearances, the NPA problem is unlikely to be resolved forever.

A bad bank may improve the health of lenders. But who will bailout the bad bank--taxpayers?