Mumbai: Creation of bad bank might accelerate the resolution of stressed assets in the banking sector, said international rating agency Fitch Ratings in a report on Friday.

“A larger-scale bad bank with government backing might have more success. However, it is unlikely to function effectively without a well-designed mechanism for pricing bad loans, particularly if the intention is for the bad bank to be run along commercial lines and involve private investors," the report noted.

According to the rating agency, banks would need capital to cover haircuts taken during the sale of stressed assets, and the bad bank would most likely require capital to cover any losses incurred during the resolution process.

The stressed asset ratio will rise in the coming fiscal year from 12.3% at the end of the September quarter and the pace of recovery is likely to be held back due to slow resolution of bad loans.

Chief economic advisor Arvind Subramanian on Wednesday said that India needs to create a bad bank quickly. Subramanian has proposed setting up a public asset rehabilitation agency to fix the balance sheets of both struggling banks and indebted companies.

“A bad bank might provide a way around some of the problems that have led Indian banks to favour refinancing over resolving stressed loans. For example, large corporates often have debt spread across a number of banks, making resolution difficult to coordinate. The process would be simplified if the debt of a single entity were transferred to one bad bank," the report noted.

According to the Fitch report, several small private asset reconstruction companies (ARCs), in the past two years, have bought only a small proportion of bad loans since banks are reluctant to offer haircuts on bad loans. Moreover, the haircuts invite the attention of anti-corruption agencies, making bank officials reluctant to sign off on them.

“We believe that the government will eventually be required to provide more than the $10.4 billion that it has earmarked for capital injections by fiscal year 2019, be it directly to state-owned banks or indirectly through a bad bank," noted the report.

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