Why proposal for bad banks to take over toxic assets may be dead on arrival

The proposal to create a large asset restructuring company, or a bad bank, which will take over toxic assets of state-owned banks, is back on the table. Earlier this month, Finance Minister Piyush Goyal, after a meeting with banking chiefs in Mumbai, said a committee under Sunil Mehta, non-executive chairman of Punjab National Bank, would look into the proposal to form a bad bank for the resolution of non-performing assets (NPA) problem.

The proposal has been discussed on and off in banking circles. Most supporters point to the success of the Troubled Asset Relief Program (TARP) in the United States in the aftermath of the Lehman Brothers crash in 2008.

What has surprised policy-watchers and banking sector experts is that this proposal has been rekindled by the government when there is already an established process of cleaning up banks' books through National Companies Law Tribunal (NCLT) under the insolvency and bankruptcy code, and concurrently recapitalising the banks through Rs 1.35 trillion worth of recap bonds.

Chief Economic Advisor Arvind Subramanian had explained the need for a bad bank, or a Public Sector Asset Rehabilitation Agency (PARA) in his 2016-17 Economic Survey. In it, he himself admitted that privately-held Asset Reconstruction Companies (ARCs) haven’t proved any more successful than banks in resolving bad debts. He, however, added that “international experience shows that a professionally run central agency with government backing — while not without its own difficulties — can overcome the difficulties that have impeded progress.”

When, in 2017, the government was looking to find an all-encompassing solution to deal with Rs 9 trillion worth of toxic assets in the banking system, Subramanian pushed for a centrally-held bad bank. However, bureaucrats in the Finance Ministry gave Prime Minister Narendra Modi and Finance Minister Arun Jaitley the option of a bankruptcy process for bad assets, as it already had legal backing under IBC. The latter option was chosen.

The IBC process is well underway, with 25 per cent of all NPAs in the banking system already being brought to the NCLT. To be sure, even if all the banks transfer their assets to a bad bank, the said bank will still have to take these assets through bankruptcy proceedings. Bankers themselves have said that the ‘haircut’ they have to take on these assets may worsen if a bad bank comes into being.

There is a political angle to it as well. Any government-backed bad bank will be seen as bailing out corporates and banks. In an election year and that could be suicidal. Hence, while the panel mentioned above continues looking at the feasibility of such a proposal, the centre may go slow on any recommendations.