A bad bank for In­dia’s toxic debt

The Pak Banker - - OPINION - Andy Mukher­jee

DES­PER­ATE times call for lu­di­crous mea­sures. Spooked by the re­lent­less surge in bad loans in In­dia's largely state-run bank­ing sys­tem, of­fi­cials in New Delhi are float­ing a new idea: the cre­ation of a govern­ment-backed bad bank.

Since the con­cept is get­ting bandied about ahead of the 29 Fe­bru­ary Union bud­get, hap­less in­vestors are be­ing forced to sus­pend dis­be­lief and start hop­ing for an In­dian ver­sion of the US's 2008 Trou­bled As­set Re­lief Pro­gramme. Af­ter los­ing 44% its value over the past 12 months, a gauge of In­dia's govern­ment- con­trolled banks has risen 5% the last four trad­ing ses­sions. That com­pares with a 2.6% in­crease in the bench­mark Nifty in­dex.

The ex­pec­ta­tions are mis­placed. It's one thing to make bro­ken pri­vate bal­ance sheets whole by shift­ing the bur­den of po­ten­tial losses to tax­pay­ers, but how does one fur­ther so­cial­ize losses for which tax­pay­ers are al­ready on the hook? Cu­mu­la­tively, state-run In­dian banks lost Rs.10,800 crore in the three months to 31 De­cem­ber, ac­cord­ing to Fitch Rat­ings. If the March quar­ter proves to be just as mis­er­able, al­most 90% of the ad­di­tional cap­i­tal the govern­ment pumped into lenders this year will be used to ab­sorb a six-month loss. Un­til the car­nage stops-and that might take sev­eral quar­ters-pri­vate cap­i­tal won't touch th­ese banks.

A TARP-like so­lu­tion could end up mak­ing mat­ters worse. Move the toxic as­sets into a new fi­nan­cial in­sti­tu­tion at near their cur­rent book val­ues, and the trou­bled lenders might be able to ac­cess cap­i­tal from the mar­ket. But the bad bank's heavy losses would still need to be made good by tax­pay­ers. Force banks to get rid of soured debt at a deep dis­count, and the bad bank might be­come an at­trac­tive as­sethold­ing com­pany. Even so, those lenders di­vest­ing the non-per­form­ing loans will be tak­ing a big one­time hit. And they'd need a pretty hefty equity infusion-cour­tesy of the tax­payer-just to main­tain a min­i­mum tier 1 cap­i­tal ra­tio of 7.5%.

Stan­dard and Poor's re­cently warned of "mul­ti­ple-notch down­grades" if cap­i­tal falls short of this min­i­mum reg­u­la­tory re­quire­ment. Con­sid­er­ing just how close some state-run banks are to the thresh­old, a botched bad-bank plan could be down­right dan­ger­ous.

In­deed, the re­luc­tance to swal­low an up­front loss and take a hit on cap­i­tal is one of the main rea­sons In­dian banks haven't sold enough of their bad debts to ex­ist­ing pri­vate as­set re­con­struc­tion com­pa­nies. The other is that the ARCs them­selves are un­der­cap­i­tal­ized.

Sep­a­rat­ing lenders from

the con­se­quences of their past de­ci­sions, with­out im­pos­ing new rules on them for the fu­ture, will merely per­pet­u­ate In­dia's cul­ture of weak lend­ing dis­ci­pline. It would be nice if in­stead of toy­ing with the idea of a bad bank, the govern­ment used its an­nual bud­get to do two things si­mul­ta­ne­ously.

One, in­ject in one fell swoop some­thing like $7 bil­lion of fresh cap­i­tal-dou­ble the cur­rent fis­cal year's al­lo­ca­tion-to al­low lenders to rec­og­nize more of their stressed loans as non-per­form­ing. That way they can make pro­vi­sions against them and pull their loan-loss re­serves up to at least 70% of soured debt, at which point in­vestor con­cern would be al­layed to some de­gree. At present, none of the staterun banks meet that re­quire­ment.

Two, lis­ten to Arundhati Bhat­tacharya, chair­man of the largest pub­lic sec­tor bank, State Bank of In­dia, and an­nounce a bold plan to re­duce the govern­ment's share­hold­ing in th­ese lenders to below 51%. Po­lit­i­cally, it will be a hard sell. Union­ized bank em­ploy­ees will be up in arms.

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