RBI and the banks have been applying bandages on the bad loans for years with no solution in sight. It may be time to draw the scalpel if the economy has to get back on its feet, writes Sangita Mehta
total bad loans at book value over 201415 and 2015-16. The structure of ARCs was such that they did not have enough capital to buy assets. They paid 5% of value of the asset and issued security receipts for the remaining. Once they recovered, they paid the banks after deducting fee.
That has been since increased to 15% now, and it would rise further to 50% in April 2017 and 90% from 2018.
“ARC is capital intensive now,” says Siby Antony, chief executive at Edelweiss ARC. “ARCs will have to have large funds at their disposal for being relevant in the current scenario.” Deputy Governor, RBI Chairman, SBI
Piecemeal solutions are not enough given the fragile financial positions of both the banks and the companies that owe them money. Estimates show that the unrecognised debts are around 4% of gross loans and perhaps 5% at public sector banks. In that case, total stressed assets would amount to about 16.6% of banking system loans – and nearly 20% of loans at the state banks, says the Survey. “The ARCs can supplement banks’ efforts to resolve the bad debt problem to a reasonable extent,” says VP Shetty, executive chairman at JM Financial ARC.
“Certain complicated cases, by which I mean those distressed loans with large outstanding debt, cannot be resolved by domestic ARC players. Even if all ARCs joined together, they will not be in a position to take over such large loans because of their low capital position.”
Stressed assets are concentrated in a remarkably few borrowers, with a mere 50 companies accounting for 71% of the debt owed by companies with interest coverage ratio of less than 1. On an average, these 50 companies owe ₹ 20,000 crore in debt, with 10 companies owing more than ₹ 40,000 crore each.
The state of affairs also blows the myth that India was not affected by the global financial crisis and the banking system was resilient. But there lies the problem. In most countries, lenders would have triggered bankruptcies and taken a haircut, thrown out the promoter and brought in a new equity investor.
But Indian lenders, at the behest of the government, threw in more good money. The belief was that time would heal the corporate wound, but banks are bleeding more because of that approach. A lack of co-ordination between banks, or borrowers playing one bank against another has been a major source of irritant for big lenders. There is also no incentive for anyone to take the lead and initiate quick recovery.
“It could solve the coordination problem, since debts would be centralised in one agency; it could be set up with proper incentives by giving it an explicit mandate to maximise recoveries within a defined time period; and it would separate the loan resolution process from concerns about bank capital,” says CEA Subramanian. Bad bank as a concept might have worked elsewhere and even in India it might work. The key issue is funding requirement.
“Even in respect of a bad bank, what you do need is capital and without capital it may not work,” says Bhattacharya of State Bank of India. “To that extent, this is a decision that the government needs to take.”
While the government is silent on the proposal without committing either way, Subramanian has suggested many ways of capitalising it, including using the reserves available with the RBI without any monetary impact. There may be private money to fund the bad bank too, if there is comfort that it would get the power to get all the disparate banks to come together and begin the recovery process without pulling in different directions.
While private lenders are able to do a better job by taking a writedown on asset value, state-run lenders are hobbled by the fear of investigative agencies coming after them for decisions that go wrong for factors beyond their control.
“In today’s climate, no banker would want to take any responsibility for debt forgiveness and, therefore, I propose setting up of an oversight committee where loans above a certain amount can be taken up for haircut,” says TT Ram Mohan, professor of finance at Indian Institute of Management, Ahmedabad. “Many of these assets have economic value and they have potential for cash flows and they would be viable if there is a writeoff. This body should be created by an Act of Parliament.”
The regulator, banks and the government have tried almost every available trick in the textbook to solve this problem, but with little success. It may be time to try the last weapon available - PARA, the bad bank, provided there is a formula to price bad loans in a fair manner. “Hard choices are easy to make when you really don’t have a choice,” said Neel Kashkari, the Indian-American who ran TARP for the US Treasury. “When the consequences of inaction are so grave, we have to step in.”
Is there a lesson for the Indian government?
I don’t think that a bad bank by itself will necessarily work, it has to be designed right. The big piece of the problem is getting banks to sell assets at a right price to ARCs and private investors who want to come in. How to get that right price to come in -by using a portfolio or a bad bank kind of a approach? I think that is going to be the key. We are going to think about what kind of design issues might help with that, but it is something if you design properly could help.
ACHARYA Anything that will help to put these stressed accounts into becoming standard would be welcome. Now, whether this is the best solution or otherwise is difficult for us to say, because even in respect of a bad bank, what you do need is capital and without capital it may not work.