Tuesday, Feb 07, 2023

Bank insecurities

Government must use multiple instruments to resolve the growing burden of non-performing assets

The banking sector in India, dominated by state-owned banks or public-sector banks (PSBs), is ridden with multiple problems. One that needs urgent attention is the high level of non-performing assets (NPAs) and restructured assets. Stressed assets (NPAs plus loans that have been restructured) for scheduled commercial banks have steadily increased over the last five years to reach 11.3 per cent of total
advances in September. For the PSBs, it was higher at 14.1 per cent. Tackling this has to be a priority because banks, which are gasping for breath today, will be expected to gallop tomorrow when the demand for credit picks up.

Asking the government to hang all promoters who contributed to bad loans and forcing write-offs of Rs 1.14 lakh crore in the last three years (‘1140,000,000,000: The great govt bank write-off’, The Indian Express, February 8) is the easiest of all demands to make. True, some fat cats have had no skin in the game — put little equity and took on large debt. They gold-plated expenditures, added to their personal wealth, and also displayed it in an obscene manner.

But it is also a fact that many others over-expanded in the hope that India would scale double-digit growth rates. In doing so, a large number got embroiled in debt. Policy logjam in infrastructure and slowing domestic growth on top of an uncertain world economy — which has refused to stabilise after the 2008 crisis — have left the corporate sector weary. While there is a case for bringing
to book wilful defaulters and conniving bank managements, targeting all and sundry will do immense damage.

How can the government resolve the NPA crisis? It must put to use multiple instruments.

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The first is to coax banks to identify bad assets. In March 2015, the NPAs, in absolute terms, were as high as Rs 3.02 lakh crore,
or 4.6 per cent of total advances. Stressed assets were as high as Rs 7.22 lakh crore. Banking analysts estimate the actual quantum of stressed assets to be much higher and these range from Rs 11.5 lakh crore to Rs 16.5 lakh crore.

The Reserve Bank of India (RBI) is goading banks in several ways to do this. The NPAs eat into profits and that is why banks hide them. In fact, banks further lend to corporates and help them service their past loans.

Second, the government must set up an asset reconstruction company (ARC) to buy these bad loans from banks. There are 15 privately owned ARCs, but they have failed because banks fear a witch-hunt by the government at a later date for having the NPAs at a particular discount. The ARCs will buy bad assets only at a discount; so there is always an element of subjectivity in pricing. If an ARC is funded by the government, it will bring credibility to the plan.


With the sale of impaired assets at a discount, banks will have to write off the amount, and take a hit. They will need additional capital, far more than the Rs 70,000 crore committed by the government over the next four years. Providing for such amounts from the Union budget presents a challenge since the government has to increase spending, to maintain the growth momentum, while trying to meet the fiscal deficit target.

Here, the government can take a leaf out of its own post-reforms handbook. Between the mid-1990s and the early 2000s, the
government deployed a unique mechanism to recapitalise banks. Monies to the tune of over Rs 20,000 crore were provided to banks for capital but the banks, in turn, invested these in government bonds. These were called recapitalisation bonds and were converted into marketable securities akin to government paper in subsequent years. This exercise was budget-neutral, meaning that there was no direct cash outgo and it did not add to the fiscal deficit. An option that suits the present scenario.

T.T. Ram Mohan of IIM Ahmedabad estimates the total cost of recapitalisation, including the proposed Rs 70,000 crore, to
add up to Rs 1,50,000 crore. A cost-benefit exercise may not be straightforward, because while costs are known, benefits are not
easily measurable. Putting a number to the damage that an economy can suffer, if a few big banks fail or if they are unable to fund the demands of a resurgent corporate sector, will be more of guesswork.


Last, but the most important, reform is to seriously start the process of de-politicising banks. In response to another recent report — ‘Govt plans to defuse ticking bank bomb’ (The Indian Express, February 1) — wherein the plan was to “take the tumour (of NPAs) out”, the head of a prominent think-tank said that “tumour” was not the right metaphor. It should be “cirrhosis of the liver”, he said, adding that if alcohol abuse caused cirrhosis, then its intake must be stopped first.

In the case of banks, the government must get out, and let them be professionally owned and managed. This is a long haul
and Indradhanush, a plan announced last August, is a babystep in that direction. Clearly, a lot needs to be done, as laid out in the
P.J. Nayak committee’s recommendations.

While banks have been recapitalised in the past, the government has so far stayed away from setting up an ARC, fearing a
moral hazard. In the US, the $475 billion worth Troubled Assets Relief Programme (TARP), which took over toxic assets of financial institutions and auto companies, eventually earned the treasury $12 billion.

In India, the moral hazard question arises only when banks are given a fresh lease without a haircut. If bad loans are auctioned and banks forced to take a haircut, then there is no real moral hazard.

The ARC can, in turn, sell these assets or, where possible, turn them around by changing the management of companies.


Of course, the government needs to stay out of ARC operations and let it be managed by experts and professionals who are not constrained by public-sector salaries.

The exercise could well serve another purpose — showing the road ahead for overhauling the PSBs.


First published on: 09-02-2016 at 00:00 IST
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