The approach of the government as well as the Reserve Bank of India to the problem of stressed assets in public sector banks (PSBs) has altered after Raghuram Rajan’s exit as the governor of RBI. In his remarks following his first monetary policy decision as governor, Urjit Patel suggested that a more “pragmatic” approach to non-performing assets (NPAs) would be followed, adding that “dealing with the stressed assets system will require creativity” and that RBI is working with the government on this issue. That’s good news for India’s PSBs, which need fresh thinking on tackling the bad loan problem. Everyone would now eagerly await the specifics of how the new approach translates into action. The signals from North Block and Mint Road have also sparked hopes about the creation of a “bad bank”.
Mr Patel pointed out that there were four stages of dealing with NPAs: Identification, recording, reporting, and finally resolution, adding the first three were adequately completed. NPAs as a percentage of total advances by Indian banks almost doubled between March 2015 and June 2016, from 4.6 per cent to 8.7 per cent. It is unclear, however, if all the problematic loans have indeed been declared. Many companies and corporate groups continue to be heavily indebted, with uncertain cash flows, and are not part of this declaration. The problem of resolution is critical, and it is here that a “bad bank” is supposed to serve as a process that identifies problem assets, takes them off the books of the existing banks, works out whether they are viable, and then passes them on at a new value. Such “bad banks” have indeed served well in several crises in the past. And the hope is that the banks will get rerated after cleansing the balance sheet, more likely to attract better valuations and be in an improved position to meet regulatory capital requirements.
But there are two issues here. One, an earlier move to set up a bad bank had raised a lot of heat as many felt that separating lenders from the consequences of their past decisions, without imposing new rules on them for the future, will merely perpetuate India’s culture of weak lending discipline. Second, the complexity involved in the “bad bank” process could be daunting. It would involve the creation of an additional independent financial institution at a time when the government is supposed to be trying to minimise its presence in the economy. Naturally, such a “bad bank” could hardly function as an actual bank — nobody is likely to want to deposit money with it unless it acquires the “bad” assets at a very attractive value. In fact, as in other places, it is meant to essentially work as a financial institution that takes over a series of assets that are considered non-performing, works out which of those can be made viable, disposes of others in the market, and eventually ends up with a relatively clean balance sheet. However, this may be difficult to achieve. First, valuing the assets properly in the transfer between the existing banks and the “bad bank” would be extremely problematic. Second, the “bad bank” would have no more leverage over bad borrowers than current banks, perhaps less.
The bigger problem could be this: While a bad bank would take care of existing NPAs, it’s unclear what happens to the possible future flow of such loans in the absence of a proper risk assessment expertise at many state-owned banks. There is also merit in the argument that the banks have to first improve their due-diligence process, acquire the ability to identify early warning signals and take prompt corrective action. Clearly, there are no short-cuts to resolving this crisis.
