Clearing up the bad debt mess

Saurabh Tripathi | Updated on January 16, 2018

Attack the problem Before it becomes overwhelming

Fear of reprisal deters bankers from taking innovative steps. The solution is to create an SPV to deal with toxic assets

Resolving the bad debts incurred by Indian banks is a complex process akin to the legendary chakravyuh from the Mahabharata. Quizzically described as difficult to enter and almost impossible to get out of, the mythological maze is the perfect analogy for Indian banks. If bold and decisive steps are not undertaken, it could result in grave loss of business confidence, anaemic private investment and diffident enterprise, potentially sending the economy into a downward spiral.

Difficulties that lie ahead…

The RBI has prescribed a set of well-intended and prudent rules, within which compromise deals can be structured for resolution of existing bad debts. Finding solutions acceptable to all stakeholders has been elusive thus far. Each case is complex, with its own peculiarities, needing customised solutions and significant subjective judgment.

High level of innovativeness are needed to find solution that satisfies all stake holders – the borrowers and multiple banks who have lent to them. In each major case, many of the bankers involved do not always see eye to eye on the solutions proposed for resolution. Since the sums involved are high and there are chances of errors of judgment, bankers are wary of taking bold decisions which may sidestep the rules. Public sector officials, in particular, have an incentive framework that actually discourages decision making and risk taking.

Some schemes proposed by the RBI encourage the taking over of management or selling of assets to alternative owners. This is impractical in India where doing business is very difficult and new management/owners may not come forward easily due to apprehensions about constraints in local ecosystems.

Most options for the resolution of bad loans seem infeasible. Banks are stuck with bad debts. Many in the industry are stuck with projects and businesses that are declared NPA and are not finding easy to move forward.

Capital flight?

Indian banks will survive even without most optimal resolution of bad debts. They will bleed red for a few years as the assets are gradually provided for and this may result in amalgamation of a few weak public sector banks. However, it does not present a national emergency of any sort. The real emergency is on account of the consequences for investment climate.

As the resolution proceedings prolong, the dwindling confidence in the Indian promoter community poses a far greater latent casualty. Many Indian entrepreneurs and promoters are beginning to feel that the system is stacked against them as the current process seems to paint all stressed promoters with the same broad brush strokes.

Personal guarantees, threats of being labelled as wilful defaulters, and the eventual chase by enforcement agencies for recoveries, weighs heavily on their minds. Not surprisingly, bankers are finding almost no new large projects to fund. Most observers are starting to notice Indian entrepreneurs looking outside the country to make investments.

The way out

We need to ring fence the problem. We should shift all the bad loans from banks books into one special purpose vehicle (SPV) created to address this problem. This SPV will be jointly held by the banks in proportion of the value of the assets transferred. Banks would get securities in return for the assets, and not cash. Since this SPV will be a subsidiary of banks, it will be able to structure deals outside the debilitating vigilance framework and resolve loans based on best commercial judgment.

The SPV should have suitable finance, legal and turnaround talent on its rolls. Overtime, as the resolved assets turn around, the relevant banks will stand to gain from the appropriate upside. However, pending resolution, the securities on the books of the banks would deteriorate in value at same rate as the value of asset would in the event of a status quo.

Given the serious economic repercussions of delay, this SPV should have direct oversight form the highest echelons of the government. We need overwhelming political backing for timely resolution.

Let’s learn from the Mahabharata in hindsight. Arjun, the most powerful warrior among the Pandavas, was actually required to overcome the challenge of chakravyuh. Instead, the highly promising yet only partially accomplished Abhimanyu was deployed and untimely sacrificed. The war would have been shorter and less destructive if Arjun had paid attention in time.

The writer heads the banking practice of BCG in India

Published on October 16, 2016

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