Monday, October 17, 2016

'Bad bank' won't take us very far

The proposal for a 'bad bank' has been revived (although the chairman of the BBB, Vinod Rai, has been quick to dismiss it).

The idea is to rid the public sector banks (PSBs) of their NPAs so that they can generate interest among potential strategic investors or so that they can be merged with stronger banks without dragging down the latter.

I doubt that the idea will take us very far. A bad bank was conceived originally as a bank-specific entity- it was mean to transfer bad assets of a given bank. The bad bank we are talking about will transfer assets of all or many PSBs. That means having to deal with problems of a different scale altogether.

Next, there's the question of whether the bad bank will be have the government as a majority owner or not. If government is to be the majority owner, then all the problems we have with loan resolution at PSBs will continue. If the private sector is to be the majority owner, setting a price at which NPAs are to be sold will be a major headache.

It's not as if the majority of NPAs have to be liquidated. No, the principal challenge in India is to get stalled projects, which have turned into NPAs, to go through to completion. That requires fresh funding. If government cannot provide funds to the existing PSBs, how is it going to provide funds for a government-owned bad bank?

Moreover, the sale of NPAs will be a time-consuming process. The interest burden will mount. Projects which can be made viable today will cease to be viable tomorrow. There's the real danger that large amounts of infrastructure investment will go down the drain. A generalised bad bank for all NPAs seems just a bad idea.

Perhaps, we could attempt something on a small scale. We could transfer some project-specific or borrower-specific assets lying with various banks to a bad bank and see whether resolution can be expedited. In general, however, it's best for the banks to resolve the problem through appropriate restructuring and waivers, supported by government funding.

There's one thing about bad loan resolution we need to be clear about. The most enduring way to get out of an NPA mess is for economic growth to revive. From that perspective, the interest rate cut we saw in the last monetary policy and the expected cuts down the road are the best solutions. The interst rate cuts will revive the financial position of many borrowers and it will help recapitalise banks by boosting the capital gains on their securities portfolio.

Loan resolution will, of course,be necessary but it will be easier to handle once economic growth picks up.

More in my recent article in the Hindu, Why a bad bank is tricky


Anonymous said...

Hi Prof,

How do you see the role of ARCs in this regard?


The Big Picture said...

Deeps A bad bank is a variant on an arc....structure is different but the same idea. So the same arguments apply. Our many arcs have been of little use in resolving bad loans ttr

Anonymous said...

lack of competition between ARCs has been the major problems thwarting resolution of stressed asset. Won't a govt backed ARC(bad bank) help in promoting the competition?

Apex loan resolution authority you propose - Is it different from sector-specific PPP Authority proposed by Kelkar Committee?

The Big Picture said...

Anonymous, Yes, it's a different concept. The idea is to give management at PSBs the courage to arrive at restructuring packages without which private investment cannot revive and banks cannot grow credit.

As for govt-backed ARC, I have highlighted the potential shortcomings in my article in the Hindu.


Stepherd said...

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