When the chief of the nation’s biggest bank says “anything that will help to put these stressed accounts into becoming standard would be welcome,” it reflects the exasperation of bankers in solving the festering bad loans problem.
That State Bank of IndiaBSE -0.50 % chairman Arundhati Bhattacharya is open to any new solution, including that of the bad bank, to sort out the bad loans problem, shows that years of revival efforts have ended up being a band-aid solution only when what was needed to end the acute pain was a surgery.
Numerous loan restructuring programmes – alphabetical soups like CDR, S4A, SDR, 5/25 – for struggling companies to get back to life, and enactments like the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act (Sarfaesi), the formation of asset reconstruction companies (ARCs) have all failed.
There was no dearth of efforts in the past three years from the regulator as well as banks to rein in the burgeoning bad loan problem. They tried many ideas like permitting banks to lend to buyout funds to buy distressed assets, the formation of joint lenders’ forum to prevent defaults, sharing of data on huge credits, etc.
Despite all that, the result has been quite disappointing as India’s stressed assets are the highest among big emerging markets at 12.3 per cent of total outstanding loans. After eight years of living with stressed assets and toying with every possible solution, banks themselves may not be able to deal with the problem anymore.
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A new idea needs to be tested out as chief economic advisor Arvind Subramanian suggests by borrowing from Sherlock Holmes: “Once you have eliminated the impossible, whatever remains, no matter how difficult, must be the solution.”
“The bad bank is a good idea if we have the ability to answer which is a transparent fair mechanism of determining clearing price,” says Uday Kotak, executive vice-chairman of Kotak Mahindra BankBSE -0.14 %.
“Otherwise, at what clearing price would a bad bank buy assets from banks?” The idea of the bad bank, or Public Sector Asset Reconstruction Agency (PARA), is old wine in a new bottle, which was presented by CEA Subramanian in his latest Economic Survey.
Such institutions have been created in Southeast Asia and even in the US. The $700-billion Troubled Assets Relief Programme (TARP) of the US Treasury during the 2008 credit crisis was there to deal with bad loans.
The bad loans problem has been a chicken-and-egg situation for banks. As sellers they were reluctant to mark down the value of the assets and potential buyers, the under-capitalised asset reconstruction companies, were unwilling to pay what the banks were demanding. One solution could be a rating of bad loans.
“To overcome this, all the NPAs should be rated,” says P Rudran, chief executive at Ambit Flowers ARC.
“Based on the rating, the pricing of the loan can be decided. Once a uniform pricing formula is accepted by all, we would see banks selling bad loans and more funds with deep pockets making entry into India.”
As the bad loans piled up, ARCs which came into being in 2003 were of little help. They bought up only about 5 per cent of total bad loans at book value over 2014-15 and 2015-16.
The structure of ARCs was such that they did not have enough capital to buy assets. They paid 5 per cent of the value of the asset and issued security receipts for the remaining.
Once they recovered, they paid the banks after deducting the fee. That has been since increased to 15 per cent now, and it would rise further to 50 per cent in April 2017 and 90 per cent 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.”
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 per cent of gross loans and perhaps 5 per cent at public sector banks.
In that case, total stressed assets would amount to about 16.6 per cent of banking system loans – and nearly 20 per cent 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 borrower, with a mere 50 companies accounting for 71 per cent of the debt owed by companies with interest coverage ratio of less than 1.
On an average, these 50 companies owe Rs 20,000 crore in debt, with 10 companies owing more than Rs 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 write off. 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?