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The non-performing assets (NPAs) of banks, particularly the Public Sector Banks (PSBs), have been in news for being excessively high for the past several years. Several steps taken by the RBI to solve the crises have almost failed. Meanwhile, the debt-ridden big private sector companies came in news with their declining earnings. These corporate entities spread across infrastructure to steel to real estate have been causing the real problem of NPAs to the banks. It means the remedy does not lie in only de-stressing the banks but similar remedy is needed in case of the corporate sector, too.
(i) High NPAs of the PSBs; and
(ii) Highly stressed balance sheet of the private corporate sector.
India has taken several steps by now to recover and control the bad loans of the banks. But they have not been very effective and banks are even today under high stress. On the other hand, India has been waiting for a recovery in the corporate sector for their balance sheet to come in good health but to no avail. Meanwhile, situation has been worsening over the time.
• The stressed corporate sector has been forced to borrow more to continue their operations, as their earnings have been deteriorating. Since the GFC, till September 2016, the debts of the top 10 stressed corporate groups have multiplied five times, to more than Rs 7.5 lakh crore. These companies have been facing difficulty in even servicing their loans.
• In the meanwhile, around 12 per cent of the total loans of the PSBs turned out to be NPAs. If some private sector estimates are to be believed, the NPAs are considerably high (around 16 per cent).
The TBS has started showing off its negative impacts on the economy—the private corporate sector has been forced to curb its investments while banks have been reducing their loan disbursals. To sustain growth, these trends need to be reversed. The only way to do so is by fixing the underlying balance sheet problems. The Survey suggests considering a different approach to address the issue of TBS—setting up a centralised ‘public sector asset rehabilitation agency’—the PARA. As per it, the agency can take charge of the largest and most difficult cases, and make politically tough decisions to reduce debt.
So far, the official strategy has been to solve the TBS through a ‘decentralised approach’, under which banks have been put in charge of the ‘restructuring’ decisions. Several such schemes have been put in place by the RBI. Most of the time, this is indeed the best strategy. But in the current circumstances, effectiveness has proved elusive as banks have simply been overwhelmed by the size of the problem. The time might have come to try a ‘centralised approach’—the PARA (a detailed discussion has been given in the new ‘Economic Survey 2016-17’). Some points are given below in support of the PARA.
Banks plus companies: Normally, public discussion of the bad loan problem has been centred on bank capital, as if the main obstacle to resolving TBS was finding the funds needed by the PSBs (we see Government recapitalising the banks since 2012-13 itself). Even if this capital is mobilised (might be up to three per cent of GDP), it will help only the banks to come out of red but
not the stressed private corporate entities (which are behind this crisis). A sustainable remedy for these corporates is also needed.
Economic rather moral problem: Whenever public discussion starts on the TBS problem it is linked to issue of crony capitalism, which looks correct also as many a time debt repayment problems have been caused by diversion of funds. But another dimension should also be kept in mind—the problem has been caused by “unexpected changes in the economic environment”, such as, the tenures of loans, exchange rates and growth rate assumptions going badly wrong. Thus, the problem is not a moral one but economic. Repetitive narratives on crony capitalism may end into punishing some but it fails us to think in the direction of incentive-based remedies.
Concentrated debts: Stressed debts are heavily concentrated in large companies, which look as an opportunity because a relatively small number of cases need to be resolved. But large cases are inherently difficult to resolve and that will be the challenge.
Debt write downs: Many of these companies are unviable at current levels of debt, requiring debt writedowns. It is believed that about 50 per cent debt write-down may be needed to restore viability among them.
Banks’ difficulty: Banks have faced difficulty to resolve NPA cases, despite RBI giving them multiple choices. Among other issues, they face severe coordination problems, since large debtors have many creditors, with different interests. If PSBs think of granting large debt reductions, this could attract the attention of investigative agencies. Debt restructuring by converting debt to equity or taking over the companies and then selling them in future to a prospective buyer— will be politically difficult, if they sell it at loss.
ARCs proving futile: The Asset Reconstruction Companies (ARCs) haven’t proved any more successful than banks in resolving bad debts and are too small to handle large cases. The ARC−bank relationship can be inherently distorted; for example, ARCs keep earning management fees for handling bad debts, even if they don’t work them out. The new bankruptcy law (legislated in 2016-17) is yet to start functioning—even after it is enforced, considerable time will be needed before it is ready to handle the large cases.
Delay is costly: Since banks can’t resolve the big cases, they have simply
refinanced the debtors, effectively “kicking the problems down the road”. But this is costly for the government, because it means the bad debts keep rising, increasing the cost of recapitalisation for the government and the associated political difficulties.
Possible variants are many though the broad outlines are simple. It would purchase specified loans (for example, those belonging to large, over- indebted infrastructure firms) from banks and then work them out, depending on professional assessments of the value-maximising strategy. Once the loans are off the books of the PSBs, the government would recapitalise them, thereby allowing them to use their resources (financial and human) in making new loans. Similarly, once the financial viability of the over-indebted enterprises is restored, they will be able to focus on their operations, rather than their finances. And they will become financially fit to borrow and go for fresh investments.
Moral hazards: Such a move looks facing moral dilemma. Of course, all this will come at a price, namely accepting and paying for the losses. But this cost is inevitable. Loans have already been made, losses already incurred and because the PSBs are the major creditors, the bulk of the burden will fall on the government (though shareholders in stressed enterprises will need to lose their equity as well). The issue for any resolution strategy (PARA or decentralised) is not whether the government should assume new liability. Rather, it is how to minimise a liability that has already been incurred by resolving the bad loan problem as effectively as possible. And that is precisely what the creation of PARA would aim to do.
Capital requirements: It would require large capital, which may be managed in the following way:
• First and the most important source of it would be the government (through issues of securities);
• Second source could be capital markets (if shares in the PSBs are sold or private sector buys stakes in the PARA);
• Third source of capital could be the RBI (the central bank may transfer
some government securities it is holding to PSBs and PARA—this will decrease RBI’s capital, the capital of the PSBs and PARA would increase. It would create no implications for monetary policy since no new money would be created).
Risks and difficulties: Creating the PARA is not without its own difficulties and risks; the country’s history is not favourable to public sector endeavours. Yet, one must ask how long India should continue with the current decentralised approach, which has still not produced the desired results eight years after the GFC, even as East Asian countries were able to resolve their much larger TBS problems within two years. One reason, of course, was that the East Asian countries were under much more pressure that they were in crisis, whereas India has continued to grow rapidly. But an important reason was that it deployed a ‘centralised strategy’, which allowed debt problems to be worked out quickly using public asset rehabilitation companies. In sum, current efforts have not been successful in addressing the TBS problem. New solutions must be tried. Perhaps it is time for India to consider the PARA as one such solution.
The approach of PARA could eliminate most of the obstacles currently plaguing loan resolution:
• 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;
• It would separate the loan resolution process from concerns about bank capital.
Though the Union Budget 2017-18 has just highlighted the concerns, it is in its aftermath that the Government has hinted to take steps in the direction of creating such a public vehicle to solve the twin crises India is faced with. Meanwhile, the Government looks busy studying the crises and working out a suitable solution.