India's new purge on bad loans will make banks sturdier. The Reserve Bank of India has proposed rules whereby lenders would start creditor crisis talks for any company that owes more than $16 million, if it misses a single repayment for more than 60 days. It sounds strict, but that's what India needs: 10 per cent of state banks' loans have already turned bad.
The new rules are an improvement on two counts. First, the new 60-day warning is tighter than current norms, under which banks have to declare a loan as sub-standard after it is 90 days overdue. Second, banks will face punitive provisioning - the amount of profit they have to lay aside to cover bad debts - if they turn a blind eye to early signs of credit stress, or try to obstruct a restructuring.
If the rules stick, they will be good for banks' earnings as well as the overall health of the system. Addressing credit quality problems early means lenders can decrease their provisions. Another important step is allowing specialist buyout firms like Blackstone and KKR to participate in auctions of distressed assets.
That leaves another problem: what to do about the 10 per cent of the state-run banks' loans that were already impaired at the end of March 2013, according to Moody's Investors Service. Since then, the economy has weakened, interest rates have hardened, and more loans have soured. Up to $6 billion in new capital may be needed in the next financial year in 15 Moody's rated banks, out of which 11 are state-owned. The government is stretched, but one possibility would be to make state-owned lenders, which control 70 per cent of the country's banking assets and are mostly listed, worth a second look for private investors. Guidelines to stop bad debts escalating can only help. But the monetary authority, which also regulates banks, must also weaken the political nexus between crony capitalists and too-pliant bank managers, and get the lenders behaving like proper companies. That is the next challenge.
