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he burden of bad debts, i.e., non-performing assets (NPAs) of banks, especially of the public sector banks (PSBs), has been increasing with every
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passing quarter for the last few years—caused by various reasons. By the end of March 2017, stressed assets of the banking system were over 12
per cent of their total loans. The PSBs that own almost 70 per cent of the banking assets, had a stress–loan ratio of almost 16 per cent. This is the main reason why for the past many quarters banks have been unwilling to process fresh loans. At the end of last quarter of the 2016-17, credit growth has become negative and the lowest in over two decades. To solve the crisis of the high NPAs, the Reserve Bank of India (RBI) has introduced multiple schemes over the last few years—Flexible Refinancing of Infrastructure (5/25 scheme), Asset Reconstruction Companies (ARC), Strategic Debt Restructuring (SDR), Asset Quality Review (AQR) and Sustainable Structuring of Stressed Assets (S4A). But these measures have not brought much relief to the banks. As conventional remedies seem to be failing to address the menace, a bit less conventional remedy is gaining ground, which suggests the Government to set up a bad bank.
Theoretically, bad banks1 work on simple concept, i.e., banks’ loans are classified into two categories, good and bad. The bad loans of the banks are bought or taken over by the bad bank while the good loans are left with the bank itself. This way, bad loans do not contaminate the good assets of banks. As banks hit by the problem of bad loans become financially viable entities, they restart their lending process. While the concept of a bad bank is simple, the implementation can be quite complicated. A variety of organisational and financial options are there to design them. The RBI has signalled in favour of setting up such a bank, but it has also highlighted the concern of ‘designing it properly’.
We find four different models of bad bank in the world depending on need of the hour, which are briefly described below:
(i) On-balance-sheet guarantee: In this model, the stressed banks get a loss-guarantee from government for a part of its portfolio (i.e., bad
assets). This is a simple and less expensive format and can be implemented quickly. Though bad loans get government guarantee, they remain on the balance sheet of the bank. It means while the bank becomes confident about its bad assets, they are still not in position to start fresh lending. This model does not fit in India’s needs of today.
(ii) Internal restructuring unit: This model is like creating a bad bank inside the stressed bank itself. Banks put their bad debts in a ‘separate unit’ inside their own financial structure and set up separate management team to handle the bad assets—the team is given clear incentives. This helps banks increase transparency (as figures related to bad loans become public) and boosts confidence among their shareholders. It however, fails to enable them restart fresh lending. This model also does not look suitable for India.
(iii) Special-purpose entity: This model is a bit different from the two described above. The bad loans of the banks are ‘offloaded’ from the balance-sheet of the banks and securitised into a kind of fund that is sold off to a diverse group of investors in financial system. In case of India these securitised bad loans can be run through sector-specific special purpose vehicles (SPVs). As the problem of the NPAs is concentrated in a few sectors (like infrastructure and metals), this model looks quite useful. As the process involves the ‘market’ (for the pricing of the securitised bad assets) the PSBs will attract less blame in this model. As the balance-sheet of banks become clean they can start fresh lending.
(iv) Bad-bank spin-off: This is the most familiar model tried across the world. In this format, stressed banks shift their bad loans to a separate banking body (i.e., the bad bank). This way the risk of bad loans is smoothly transferred from the stressed banks’ balance-sheet to the bad bank making banks viable to start fresh lending. Though this format looks the most suitable one for India’s situation, it needs certain arrangements to be put in place, such as setting up a separate body, putting desired kind of management skill in place, information systems and proper regulatory mechanism being the major ones. This is an expensive model, too. The idea of a public sector asset rehabilitation agency (PARA) suggested by the Economic Survey 2016-17 falls in this category. However, the PARA is supposed to address another problem
also—the stressed balance-sheet of some private sector corporate entities.
The situation of the bad loans in the banking system has reached such a level that it has started hitting the investment prospects in the economy, and they need immediate attention from the Government, as per the Economic Survey 2016-17.
If we go by the proposition of the survey, it looks suitable for the Government to think in the direction of setting up a separate body in the line of the PARA. Setting up a bad bank will only address the problem of banks’ bad debt and may make them fit to restart lending. But this will not promote the cause of investment in the economy as some big corporates are unfit to borrow (on whom depends the investment prospects). It means India needs to leverage these corporate entities, too. In the aftermath of the presentation of the Union Budget 2017-18, the Government expressed its willingness in the direction of setting up such a body in the coming months. Meanwhile, business, industries and banks in India are waiting for the Government initiative in this regard.