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Looking beyond the idea of a bad bank

LiveMint logoLiveMint 01-03-2017 Livemint

As the asset quality in the banking system continues to remain a drag for the Indian economy, the idea of a bad bank is beginning to attract renewed attention. The chief economic adviser to the government, Arvind Subramanian, recently said that India quickly needs to create a bad bank. In a speech last week, the deputy governor of the Reserve Bank of India (RBI), Viral Acharya dwelt upon the possible structure of asset management companies that can deal with bad assets. The latest Economic Survey proposed the idea of a public sector asset rehabilitation agency (PARA).

The reasons for this rising interest in creating an institution, or set of institutions, that can help solve the bad debt problem, especially in public sector banks, is not very difficult to understand. The gross non-performing assets (NPAs) in September 2016 reached a high of 9.1% and most of these are concentrated in the books of public sector banks. Further, a number of regulatory changes made by the RBI over the last few years have not yielded the desired outcome. Consequently, policymakers are now exploring the idea of a bad bank.

The Economic Survey, for instance, has suggested a public sector agency (PARA) which will work on commercial principles and will be staffed with professionals. The agency will be mandated to maximize recovery in a short period and the government will own only a 49% stake. Acharya, in his speech, highlighted two models of asset management companies—a private asset management company and a national asset management company.

It is encouraging that efforts are being made and solutions are being sought to ease the stress in the banking system which, among other things, is holding back the flow of credit.

There have been several successful instances of resolution of the NPA problem in different countries in the past. For example, asset management companies formed in Sweden after the banking crisis of the early 1990s have done well. One of the underlying features of the resolution of the banking crisis in Sweden was political unity. Highlighting the relevance of political unity, a 2009 European Commission paper noted: “Political unity eased the passage through parliament of measures to support the financial system. In addition, representatives of the opposition had a full insight into the resolution process, thus maintaining political accord…Political unity was most necessary in terms of adopting a swift, decisive and lasting approach.” The Korea Asset Management Corp. has also been successful in resolving the bad debt problem in Korea after the Asian financial crisis, while the bank investment programmes under the Troubled Asset Relief Program, implemented after the 2008 financial crisis in the US, has earned positive returns for the government.

India can learn from the international experience, but implementation will remain a challenge for a number of reasons. In order to resolve the problem, banks will have to take a significant hit to make bad assets attractive for asset management/reconstruction companies. It is a well-recognized problem that public sector banks have no incentive to do this. On the contrary, enthusiasm to clean up the balance sheet by writing off bad loans might attract the attention of investigative agencies and make life difficult for the management. Further, since a lot of bad debt is concentrated in the books of large firms, write-offs could be seen as favouring some companies and could have political implications for the government. The government would not want to be seen as bailing out some industrialists.

Setting up a state-backed agency will also not be easy. In the present environment, it will be difficult for the government to form a political consensus in support of bold measures to solve the bad loan problem. It will also require fiscal resources to capitalize both the asset management company and the public sector banks, which could be a tough ask due to the given fiscal constraints. A significant diversion of fiscal resources will affect the government’s capital expenditure, which will have a bearing on growth as private investment continues to remain weak. Therefore, given the political and economic complexity, getting out of the present situation will not be easy.

To be sure, some of these problems are a result of government ownership which doesn’t allow banks to write off bad debt, raise capital and move on. If business decisions go wrong, shareholders are bound to take a hit. In the case of public ownership, it’s the taxpayer who suffers. So, as ways and means of reducing stress in the banking system are being debated, it is important to also find ways to progressively reduce the burden of funding commercial enterprises, including banks, on taxpayers. Privatization of public sector banks is one big reform that the Narendra Modi government should be targeting.

What should the government do to solve the bad debt problem in the banking sector? Tell us at views@livemint.com

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