Question marks over bad loan plan
Arvind Subramanian, the outgoing Chief Economic Advisor, thinks India’s bad loan problem can’t be solved in a year or two. Piyush Goyal, the minister in charge of finance, would like to give it his best shot. Mr Goyal has unveiled Sashakt, a five-point plan to resolve non-performing assets. Sashakt is long on intent, short on detail. Besides, solving the bad loan problem is not the same as solving the problem of public sector banks (PSBs) that account for two-thirds of India’s banking sector.
Two of the ideas Mr Goyal has put forward, bank-led resolution and creation of an asset management company (AMC), are hardly new. Under the former, bad loans in the range of ~500 million-~5 billion will be assigned for resolution to a lead bank through an intercreditor agreement. The resolution will happen within 180 days.
The inability of banks to reach agreement is one reason that bank-led resolution has not worked so far. Another reason is that banks will have to take significant haircuts in any resolution. In the present climate of investigations and arrests of bank managers, can we realistically expect bank management to delegate the power to take haircuts to the lead bank?
Bad loans of over ~5 billion will be dealt with through multiple asset management companies (AMCs). The AMCs seem to be asset reconstruction companies (ARCs) by another name. The AMCs will do what the existing ARCs seldom do, namely, manage, reconstruct or nurse assets back to health. Most ARCs simply buy at steep discounts and then try to dispose of the assets at a higher price.
The AMCs will face all the problems that stalled the creation of a bad bank. Raising funds on the scale required is no easy task — there is no indication that sovereign wealth funds and private equity funds are waiting to jump in. If the AMC is to have more than 50 per cent private ownership, valuations at which bad loans are transferred will be a thorny issue. The slightest hint of undervaluation in the sale of bad loans to AMCs will raise howls of ‘scam’, precisely what the government would like to avoid in the run-up to general elections in 2019.
Public sector banks (PSBs) will require an infusion of capital after the haircuts they will take on bad loan sales to AMCs. It is suggested that the ~650 billion of infusion by the government planned for 201819 (as part of the ~2.1 trillion recapitalisation planned announced in 2017) would be adequate and can be supplemented by the sale of noncore assets. The rating agencies and market analysts don’t think so. They believe a much larger infusion by the government will be necessary.
The AMC mooted under Sashakt is rather different from the AMC proposed by banks and power finance companies for the resolution of stressed assets in the power sector. The power sector plan envisages transfer of stressed assets at net asset value (that is book value minus provisions). Banks will not be required to take haircuts and hence no fresh infusion of capital is required. This is what makes the power sector plan attractive.
The power sector AMC would avail of the expertise of NTPC and other public sector companies in the power sector in restoring stressed assets back to health. Sashakt talks of roping in teams of specialists for the multiple AMCs envisaged for various types of assets. Where are the specialists going to come from? Besides, the clock has already started ticking on the 180-day deadline set by the RBI for resolution of NPAs. Going down the AMC route will require an extension of the deadline set by the RBI. On recent showing, it’s hard to see the RBI obliging.
In short, Sashakt bristles with issues. The underlying motivation, finding alternative mechanisms to the IBC route, is laudable. The IBC route is already getting clogged and matters are compounded by resort to litigation by various parties. Banks face the prospect of poor recoveries under the IBC route.
The bank-led resolution should be the preferred first choice. For this to happen, however, the necessary conditions should have put in place long back. These include empowerment of boards and management at PSBs and a commitment to back resolution through whatever capital is required. The NDA government has failed to do so.
Solving India’s bad loan problem requires taking a view on PSBs. No clear view has emerged over four years of the NDA government. You want to keep the PSBs after resolving bad loans? Then, you must be ready to infuse massive amounts of capital and overhaul governance at PSBs. The necessary capital has not been forthcoming and key appointments have happened only in recent weeks. The other option is keeping PSBs but having fewer of them through consolidation. Trouble is, there aren’t PSBs strong enough to digest others.
If you don’t want to keep some of the PSBs, you must be willing to resort to strategic sale. This has been talked about off and on but, more recently, privatisation has recently been ruled out. Subramanian is right. India’s bad loan problem and the larger problem of PSBs is fated to drag out until well past the formation of the next government in 2019.