‘Creation of bad-debt bank is a good idea’

To free Public Sector Banks (PSBs) from the toxic assets that have been haunting their balance sheets for quite long, the Economic Survey espouses setting-up of “bad-debt” bank which would essentially embrace all bad loans of PSBs, thus allowing banks to concentrate on their core banking obligation of providing credit to the economy. The survey advocates urgency in setting up such a bank, to be called Public Sector Asset Rehabilitation Agency (PARA), which would be backed and funded by the Central government and be tasked with working out “the largest and most complex (NPAs) cases”. Any further delay in finding a logical solution to the NPAs, says the Survey, would be “costly for the economy”, as “impaired banks are scaling back their credit, while stressed companies are cutting their investments”. 

The size of bad loans as on September 2016 stood at $160 billion (over Rs 12 lakh crore), 80% of which is in PSBs. The non-performing ratio of PSBs is still at an alarming level of 12%. The Survey also points out that nearly 40% of the corporate debt is owed by companies which do not earn enough to pay even the interest obligations on loans. “Bad-debt is a vicious cycle, the more one has, the more bad debts get created. It spreads like cancer in the economy, so there is an urgency with which PARA is needed,” says Dr Jaijit Bhattacharya, partner at KPMG India. 

There is an acknowledgement within the government that instead of postponing it forever, the NPAs’ problem needs to be recognised and solved even with some genuine losses. Unless this is done, economic growth would continue to remain under threat.

The size of bad loans as on September 2016 stood at $160 billion (over Rs 12 lakh crore), 80% of which is in PSBs. 

PARA would purchase specified loans (for example, those belonging to large, over-indebted infrastructure and steel firms) from banks and then try to turn them around, either by converting debt to equity and selling the stakes in auctions or by granting debt reduction, depending on its professional assessment. 

Once the bad loan portfolio is taken out of the banks’ balance sheets, the government can capitalise the PSBs to make them able to extend fresh loans in the economy. Though similar arrangements (creation of Asset Reconstruction Companies) have been made in the past, such mechanism failed mainly due to the fact that such ARCs did have the required (capital base) bandwidth for resolving bigger cases.     

All of this would certainly have a cost which would be funded by the tax payers’ money. So PARA should not be created as a continuous institution, cautions many economists. PARA needs to be structured properly so as not to give a feeling that anybody can merrily take loans and run away with it. 

Similarly, banks should not be allowed to take undue advantage of this route available to them. Only such bad debts which have been created due to genuine unexpected economic events need be resolved within this mechanism.

One of the highlights of PARA is that it would not assume the bad loans of private sector banks. Many do not see a rationale to such exclusion. 

The only reason to such exclusion seems political as the government would be accused of helping private interests.