A consensus on a “practical resolution” to the Rs 4.76 lakh crore bad debt problem, which was identified by the National Democratic Alliance (NDA) government in its initial days as the biggest headwind to restarting growth, is likely soon. A proposal to push private asset reconstruction companies (ARCs) to take on the toxic assets of public sector banks is gaining traction within the government as the most practical way to resolve the banking sector mess, which is seen as hampering the Indian financial sector’s ability to fund productive sections of the economy.
The large number of non-performing assets on the books of state-owned lenders have been attributed to both sectoral factors as well as bad business decisions, and while a number of schemes were announced by the government as well as the Reserve Bank of India, the situation has shown no tangible signs of improving. Apart from the option to back private sector ARCs, another idea that has been floated was that of setting up a state-owned agency. However, the increasing realisation within the government is that this option is not expected to see light of the day due to its political implications.
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“We can’t solve the NPA issue just through one single instrument. In today’s date, private ARCs appear to be a better idea. Four-to-five of the top private sector ARCs should be sounded out, and they should be strengthened by allowing them to borrow up to Rs 10,000 crore from the banks provided they can raise the same amount from the market,” the official said. “Some of these private firms,” the official said, “have been approaching us, and are ready to come in if a concrete plan is put into place.” An auction model for transferring the bad assets from the banks to the ARCs is being seen as the most feasible option.
The official also said that the Centre would be working towards the target of holding at least one auction of toxic assets over the next one year or so. He added that while the option of private sector ARCs may be better in a practical sense, banks “would want to wait for a plan” that buys assets from them at face value, something, which is being considered for the public sector agency to do. “The Indradhanush scheme was also a good plan in-principle, but Rs 70,000 crore is a small amount for the size of the problem that exists,” he said. A public sector asset rehabilitation agency (PARA), was proposed in the Economic Survey of 2016-17, and while was being looked at as an in-principle instrument for resolution of the twin balance sheet problem of “overleveraged companies and bad-loan-encumbered banks”, it has thus far not found any backing, including from the central bank.
The hurdles on the implementation front, though, include the expectation that banks may have to take a significant hit to make bad loans attractive for ARCs. Public sector banks are unlikely to have sufficient incentives to do this and a fear of action by enforcement agencies could prevent bankers from getting into a negotiated settlement or sign off on “haircuts” in case of companies where the loans have gone bad. The other apprehension is that since much of the bad debt is concentrated in the books of a handful of big corporate groups, write-offs could be seen as a bailing out of industrialists, something that may be unpalatable from a political point of view.
The private ARC option, in this respect, is seen as a much more feasible option in comparison to the state-owned ARCs, where difficulties are envisaged in forging a political consensus. Besides, the prospect of pledging fiscal resources to capitalise both the asset reconstruction company alongside the recapitalisation of public sector banks could mean the diversion of a substantial amount of fiscal resources, something that is unlikely to enthuse the government. Instead, some amount of implicit support to the private ARCs is being seen as a more feasible option.
RBI Deputy Governor Viral Acharya, in his first speech as a representative of India’s central bank, also expressed his concern with the option of bad bank. Acharya, too, has earlier pointed towards the possibility of setting up the bad bank to deal with the stressed assets of other lenders, but said in his speech last month that he was not in support of this option for resolution. “Resolution agencies set up as banks that originate or guarantee lending have ended up being future reckless lenders, notably in the case of Germany which has often aggregated stressed assets of its Landesbanken into bad banks. I would argue this has also been the story of Fannie Mae and Freddie Mac with respect to housing booms and busts in the United States,” Acharya had said.
“It would be better to limit the objective of these asset management companies to orderly resolution of stressed assets with graceful exit thereafter; in other words, no mission creep over time to do anything else such as raise deposits, start a new lending portfolio, or help deliver social programs,” he added.
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 last 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.