With Raghuram Rajan gone, idea of ‘bad bank’ is back on policy table

Rajan had opposed the idea suggesting that it would make sense for the banks themselves to recover the dues.

Written by Pranav Mukul , Anil Sasi | New Delhi | Updated: October 4, 2016 3:57 pm
raghuram rajan, India RBI, indian banks, bad loan, NPA, Raghuram Rajan, banking sector, Indian economy, Urjit Patel, bad loans issue, economy news, banking news, business news, india news Former RBI governor Raghuram Rajan (File Photo)

THE CHANGE of guard at the helm of India’s central bank could prompt a rekindling of a proposal for setting up a “bad bank” to absorb toxic assets from loss-laden state-owned lenders, a senior government official told The Indian Express.

This comes amid growing realisation in policy circles that the measures taken till now to tackle the burgeoning loan problem in the country’s banking sector, which is seen as hampering the financial sector’s ability to fund productive sections of the economy, are still short of yielding tangible results.

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Former Reserve Bank of India (RBI) governor Raghuram Rajan, who made way for Urjit Patel on September 6, was fundamentally opposed to the idea of a “bad bank”, which is envisaged as an entity that would buy non-performing assets from other banks to free up their books for fresh lending and then suitably dispose of the toxic assets.

“Some movement (on the bad loans issue) could happen in the next two to three months… now that there’s a new RBI Governor, it raises the possibility. The previous RBI governor was not keen on clean-ups through a bad bank and Asset Restructuring Company.

It is also necessary for the finance ministry to be on board with the idea,” said the official, who plays a key role in top-level policy formulation in the government.

Rajan had opposed the idea suggesting that it would make sense for the banks themselves to recover the dues. He had maintained that in cases where loans are not priced appropriately when transferred to a “bad bank”, it could create issues. Rajan was also firmly of the view that the concept of a good bank and bad bank may not be relevant for India since much of the assets backing the banks’ loans are viable or can be made viable.

But the official, who did not wish to be named, reaffirmed that there is increasing realisation within sections of the government that the recapitalisation of public sector banks as a solution for tiding over bad-loan losses could only go so far, “purely because of the country’s finances being limited”.

“In the end, the problem doesn’t get sorted out. You might recapitalise the banks, but assets are not getting cleaned up. What you do through recapitalisation is probably give some more life to projects, while at the same time allowing banks to lend more credit, but that still doesn’t get rid of the toxicity in the assets,” said the official.

He said that there are countries that have tried to do it (set up a bad bank) in the past, and that “nobody has failed”. “The complaint has generally been that it wasn’t done fast enough,” he said. The RBI did not respond to an email sent by The Indian Express seeking comment.

A “bad bank” was initially proposed to resolve the loans issue, and it would take over assets from public sector lenders, thereby forcing them to focus on their normal commercial activities. The concept was pioneered at the Pittsburgh-headquartered Mellon Bank in 1988 in response to problems in the bank’s commercial real-estate portfolio. According to McKinsey & Co, the concept of a “bad bank” was applied in previous banking crises in Sweden, France, and Germany.

In India, a revival of the proposal comes at a time when the gross bad loans as a percentage of total loans of Indian banks have nearly doubled to 8.7 per cent as of June, from 4.6 per cent in March last year, according to RBI data. If rolled-over or restructured loans were to be also considered, 12 per cent of all bank loans were stressed as of end-June.

Measures tried out by policy makers have failed to adequately stem the rot in India’s banking sector. In 2014, the RBI had come up with a scheme that permitted banks to extend the maturity of loans given to companies in the infrastructure sector. In 2015, it extended banks the option of converting a part of the debt into equity and taking a controlling stake in overleveraged companies. In June this year, the central bank floated yet another instrument called the Scheme for Sustainable Structuring of Stressed Assets (S4A plan), which allowed lenders to split the outstanding debt of a stressed company into sustainable debt and equity with some riders.

Besides, the Bankruptcy Code is not expected to yield results in the next couple of years. Also, the fear of action by enforcement agencies is seen as preventing bankers from getting into a negotiated settlement or sign off on “haircuts” in case of companies where the loans have gone bad.