BackGovernment ARC: a bailout by another name
The NDA government shouldn't get in the business of handling bad loans
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It is well known that one of the key stumbling blocks in improving India’s growth prospects is the high level of corporate leverage, especially in key sectors such as infrastructure and construction that are vital to reviving growth. But the National Democratic Alliance (NDA) government’s remedy for this problem may be worse than the disease.
The government plans to set up two asset reconstruction companies (ARCs) to clean up bad debts in the power and roads sectors. Shorn of the financial intricacies, this essentially means the government will directly take charge of the bad loans in the two sectors. While both bankers and borrowers will be pleased with such an arrangement, the tax payer is likely to be left holding the can. Such an arrangement is also likely to be subjected to future investigations by audit and other investigative agencies, given that a state-sponsored ARC can very easily turn into a fountainhead for corruption in India, with firms trying to corner sweetheart deals.
Even worse, such an arrangement will generate perverse incentives for overleveraged sectors in the future, and there will no stopping firms in other sectors from seeking similar bailout packages.
It is nobody’s case that bad loans should not be restructured. Indeed, a well-functioning market for bad loans and restructured assets can help ease capital constraints in the banking system. But such a market relies largely on private equity funds in most other economies and that is how it should be in India as well. The government and the regulator’s role should be restricted only to facilitating orderly growth of the secondary loan market, not in actually taking part in such markets to buy up bad loans.
This is not the first time that a proposal for a public sector asset reconstruction company has been floated. A similar proposal came up during the first NDA regime as well, at a time when Indian industry was going through a recession, and bad loans in the banking system had spiked. Thankfully, the proposal was nixed at that time and instead a new regulatory framework for ARCs was created by legislating the Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest Act in 2002. That act led to the setting up of the first few ARCs in India. To be sure, there were several deficiencies with the regulatory framework. For one, rather than granting exclusive powers to ARCs, the Act put ARCs on par with banks. This meant that ARCs were not seen as specialist institutions, capable of handling and turning around bad assets. Instead, they turned into buyers of last resort for banks. Also, the funding needs of ARCs did not receive the attention they deserved.
Over the past year, the Reserve Bank of India (RBI) seems to have woken up to the importance of the asset reconstruction mechanism in dealing with the problem of debt overhang, and has liberalized rules relating to the secondary market for bad loans. For instance, earlier this year it allowed private equity funds to participate in auctions of bad loans. Prodded by the regulator to offload bad debt, the past year saw a renewed rush by banks to sell off assets to ARCs.
The government’s latest move can undo the impact of the recent reforms of RBI to help expand the secondary market for bad loans, and crush an incipient recovery in the ARC industry. Rather than launching asset reconstruction firms, the finance ministry should put in place a fast and effective framework for bankruptcy proceedings, and work in tandem with RBI to develop a robust market for bad loans, where private firms develop specialist capabilities in dealing with stressed assets.
Setting up state-sponsored ARCs will only mean that we forget all about the bad debt issues till they come back to bite us after a few years. One of the key reasons for the high levels of corporate leverage in the economy today is regulatory forbearance on the part of RBI and the finance ministry in the years immediately following the great financial crash of 2008, which has led to a pile-up of bad debts in the financial system.
We must avoid making a similar mistake of kicking the can down the road now.
Should the government involve itself directly in managing bad loans? Tell us at views@livemint.com
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