A bad, good idea

The Indian economy today faces weak loan growth and high NPAs; a nexus between the banking system and stressed borrowers is mostly blamed for this crisis.

How do we tide this over? Recapitalisation of public sector banks (PSBs) alone will not result in a rise in bank lending, especially when banks are not sure of the extent of losses that existing bad loans would inflict. Stressed borrowers won’t commit fresh investments unless their financial positions improve.

So, there is a pressing need to swiftly address the NPA problem, both to revive private investment and to boost credit growth.

India has already attempted to get around this problem through Strategic Debt Restructuring (SDR), which allows banks to convert their loans to stressed firms into equity, and Scheme for Sustainable Structuring of Stressed Assets — which allows banks to bifurcate their debt to a stressed account into sustainable and unsustainable portions — but with little success. So the time is ripe for thinking about an out-of-box solution.

Here, the idea of creating a government-backed bad bank gains significance. Such a bank would absorb impaired assets from banks, freeing up their books for fresh lending. Importantly, it does not need to exist perpetually and, after the sale of impaired assets, it would essentially be wound down, weakening the argument that it would create the problem of moral hazard.

Will instituting a bad bank alone offer a permanent solution to the NPA problem? That this problem has exacerbated means a single instrument might not be able to overcome it. So what we need now is a holistic approach: apart from creating a bad bank, progressing further on three more initiatives is tantamount to such an approach.

First, once banks transfer their stressed loans to the bad bank, the latter will have to recover dues from such assets to the maximum extent possible. To enable this, an ecosystem facilitating speedy asset disposal must be in place.

The new bankruptcy code is unprecedented and is expected to transform stressed assets recovery landscape. However, for this to be distinct from earlier attempts, the National Company Law Tribunal must have adequate administrative and judicial staff.

Second, banks should be ready to take receipt of steep haircuts while transferring bad loans. Nevertheless, the participation of a government-backed bad bank in the stressed asset sale process might lower the extent of losses.

Three, once banks have taken haircuts, they will have to be recapitalised in order to facilitate smooth credit flows. This investment might fetch greater returns, as removing the NPA-related uncertainty itself could add a substantial value to stocks of PSBs.

But it must be ensured that the current stressed asset problem does not repeat. This calls for concurrently strengthening governance of PSBs and gradually reducing the government’s role in its operations.

Already, there is an institution, Bank Bureau Board, to achieve the former, and the proposal to set up a bank holding company, transfer of all government holdings in PSBs to it and lower government holdings below 50 per cent must be expedited.

The writer is an economist

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