A deep surgical process

Nearly a week ago, the governor of the Reserve Bank of India (RBI) had spelt out the approach of the central bank and the government to the problem of non-performing assets (NPAs) in the Indian banking system. It was both important and good that he stressed that the regulator and the government were on the same page on this matter. Most newspapers caught on to his reference to the need for a “deep surgery”. They ignored the interesting contrast he drew between the Indian banking sector woes and that of China’s. He said that, in India, underlying many of these stressed loans was an economically viable productive asset, not ghost townships.

He was also right to stress that between cleaning up the bank balance sheet and tending to economic growth, his unambiguous preference was for cleaning up. Indeed, it is a false choice. Without a healthier bank balance sheet, sustained economic growth is not possible. In theory, it is easier to address stressed assets when growth is good, but in fact, problems are forgotten in good times and not addressed. Only crises induce change because they exacerbate the painful effects of the problem. So, now is the opportunity to fix the problem in an enduring manner.

In general, there are two approaches to handling NPAs. One is asset reconstruction and the other is asset disposal. India has opted for the former. That might have been the preferred route in the international context where the public sector (the government) might have wanted the private sector banks to have “skin in the game” in terms of helping with debt recovery because they created the problem in the first place.

In the Indian context, I think there is a prima facie case to believe that it would be more effective to cut the ties between government-owned banks and their clients by going for a clean sale of the asset to the Debt Disposition Company (DDC) and leaving it to them to deal with the borrower fully. That will be privatization of the debt. Currently, the taxpayer is on the hook for the debt. With the outright sale and transfer of all legal rights to the securitization companies (SCs)/reconstruction companies (RCs), the ‘taxpayer’ recognizes the loss early and the money realized can, hopefully, be put to more productive and profitable use by the bank, making up for the loss, somewhat or fully.

What follows is an attempt to spell out some of the elements of the “deep surgery” that the RBI governor had warned of:

(1) Indian banks should be provided both the options of asset reconstruction and asset disposal. The DDC should be licensed. This provides for a diversity of options for banks. They can take the disposal route or the reconstruction route. Over time, depending on effectiveness, one solution will dominate the other. Right now, there is no choice other than reconstruction. Of course, the deadlock in debt disposal will be the price at which the debt is sold off to the SCs/RCs. I think RBI, assisted by credit-rating agencies and relevant industry experts, should be the final arbiter on this matter. This should be explained to the public by way of advertisements, speeches and others so that it is not seen as a corporate give-away when a 100% debt is sold at, say, 30% or 40%.

(2) Further, for the debt disposal process to be credible, even if it involves some delay, the Comptroller and Auditor General (CAG) should be involved from day one so that no mala fide is attributed later, with the benefit of hindsight gleaned from an improved economy (which might well have been triggered by the very debt resolution itself). In spirit, this is the same as income tax assessees seeking an advance ruling on income-tax matters to avoid expensive litigation and delays later.

(3) Third, as the RBI governor has said, in the case of deliberate malfeasance, the full force of law must be brought against deliberate fraudsters. According to a report by Alvarez and Marsal published in 2014, “advance related frauds” (of more than ₹ 1 crore) had gone up from 242 cases in 2010-11 to 2,760 cases in 2013-14 (not full-year figure). The report adds that the lack of credibility of promoters was one of the top issues that banks were facing in restructuring/recovering NPAs.

(4) Simultaneously, at least for the banks that have the maximum impaired assets, governance reforms must be very thorough, including the replacement of management up to loan officers. The kind of governance and management changes can be defined ex-ante, depending on the impairment levels and ratios.

(5) Perhaps, one way to let banks have “skin in the game” is to give them a share of the super-normal profits so that they can and will continue to share vital information with SCs/RCs that would help in the collection of debt.

Therefore, in the spirit of “multiple policy experiments” that the country needs, the government should facilitate both rapid debt disposal and debt resolution routes. Let banks experiment with both and, over time, let the country adopt the one that works better in the Indian context.

V. Anantha Nageswaran is an independent financial markets consultant based in Singapore.

Comments are welcome at baretalk@livemint.com. To read V. Anantha Nageswaran’s previous columns, go to www.livemint.com/baretalk