New Delhi: The cost of recapitalising India’s struggling banks would be affordable even under a negative scenario, the International Monetary Fund said on Wednesday, urging government steps to strengthen the financial system.

Weighing into a renewed debate on tackling India’s $130 billion in stressed loans, the IMF said “recapitalisation costs should be manageable" at between 1.5 and 2.4% of forecast GDP.

Of that total, the government’s share would be between 1.0 and 1.6% of gross domestic product (GDP) over the four years to March 2019, assuming that 40% of loans have to be provided against.

India’s finance ministry earlier backed a call by the Reserve Bank of India to set up a “bad bank", saying urgency was needed to address troubled loans weighing on the banking sector.

Also Read: India needs to create a bad bank quickly: Arvind Subramanian

“It’s very positive that both the RBI and the government are putting a shared focus on addressing the balance-sheet problem," IMF resident representative Andreas Bauer told a conference call.

Centralised bailout programmes have had mixed success in the past and it would be important, Bauer said, to examine the design of the mechanism that would kick in now that the process of recognising banks’ bad loans is nearing completion.

The estimates were contained in the IMF’s annual report on the Indian economy, in which it said that “elevated corporate sector risks and heightened levels of non-performing assets in public sector banks continue to pose risks to banks’ soundness".

The IMF also emphasised the importance of strengthening banks’ capital buffers, reforming their governance and boosting the capacity of mechanisms to get troubled loans off their books.

Also Read: Is Viral Acharya’s solution for stressed assets viable for Indian banks?

In a special report on corporate and banking sector risks in India, the IMF said recapitalisation costs would be “significantly higher if there is a policy shift to more conservative provisioning requirements".

In case of a rise in the provisioning ratio to 70%, cumulative recapitalisation needs would increase to 3.3-4.2% of forecast GDP in the fiscal year to March 2019, with a government share of 2.2-2.8%, the IMF said. Reuters

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