NPA resolution: What RBI can learn from China’s strategy against bad loans

The non-performing asset (NPA) situation has been one of the most contentious issues in the country over the last few years. Even though demonetisation has been the issue du jour recently, the issue of NPAs has been at the forefront of the banking fraternity’s concerns in the last year. In the context of an ordinance issued by the government to provide more independence to the Reserve Bank of India (RBI), it is important to understand what can really be done, considering that RBI has more powers to address this issue. The question for the RBI now is: How will it solve the problem? While experts have commented on various measures, it would also be prudent to look across the border to China to see how to deal with this.

NPAs are not a new phenomenon. They have been a part of our system over the years and have come up during certain economic cycles with prominence. In the chart, the NPA ratios of India and China are illustrated over a 15-year period beginning in 2001. As chart 1 illustrates, China’s NPAs in the early 2000s were far higher than India’s were from the period 2001-2005. Since then, China has made a significant effort to fine-tune NPAs; today, they are much less than in India.

It is also interesting to note that during the same period, lending by Chinese banks has been far higher than by Indian banks, which have been historically reluctant to extend credit and even more reluctant lenders post the 2008 financial crisis (chart 2). So how did the Chinese go about solving the NPA problem they had in the early 2000s?

They adopted a four-point strategy to address the problems. The first was to reduce risks by strengthening banks and spearheading reforms of the state-owned enterprises (SOEs) by reducing their level of debt. The Chinese ensured that the nationalized banks were strengthened by raising disclosure standards across the board.

The second important measure was enacting laws that allowed the creation of asset management companies, equity participation and most importantly, asset-based securitization. The “securitization” approach is being taken by the Chinese to handle even their current NPA issue and is reportedly being piloted by a handful of large banks with specific emphasis on domestic investors. According to the International Monetary Fund (IMF), this is a prudent and preferred strategy since it gets assets off the balance sheets quickly and allows banks to receive cash which could be used for lending.

The third key measure that the Chinese took was to ensure that the government had the financial loss of debt “discounted” and debt equity swaps were allowed in case a growth opportunity existed.

The fourth measure they took was producing incentives like tax breaks, exemption from administrative fees and transparent evaluations norms. These strategic measures ensured the Chinese were on top of the NPA issue in the early 2000s, when it was far larger than it is today. The noteworthy thing is that they were indeed successful in reducing NPAs. How is this relevant to India and how can we address the NPA issue more effectively?

It is important to note that we have followed some parts of the strategies mentioned above, but not in full. One of the key points, mentioned by the IMF as well as others, is the need for an environment for fair valuation of assets. In the context of cases such as Kingfisher Airlines (where only one bidder eventually came forward), the role of asset reconstruction companies becomes very important. There need to be more structural protections for fair valuations, especially in the context of the bankruptcy law that was passed by Parliament last year.

Another important point that has bypassed the domestic policy narrative is securitization. The thinness of the domestic investor base needs to be overcome, coupled with a robust securitization structure. In addition, this process should involve the transfer of debt to privately managed specialist vehicles that have a clearer mandate and expertise to engage in corporate restructuring. Only this method has the potential to drive faster restructuring of a debtor company, otherwise securitization will merely change the ownership of its debt.

The RBI must make a concerted effort to distinguish between genuine performance-related loan issues and companies that are taking the system for a ride. For example, the top 10 corporate groups in India owe more than Rs5.73 trillion to state-controlled banks. Generic regulatory control is affecting the credit flow to small and medium-sized enterprises (SMEs). It is important that schemes such as the Pradhan Mantri Mudra Yojana are promoted in tandem to provide credit to genuine SMEs and stricter measures are first directed at the big companies that own large chunks of NPAs at the national level. This distinction is important to address the problem in a more targeted manner and find effective solutions without affecting genuine business professionals and entrepreneurs at large.

To conclude, it is important to look at some of the key measures taken by other countries to address the NPA issue. China’s NPA rescue mission is one such case study. India should learn from it, especially in the context of valuation, securitization and more targeted NPA redressal mechanisms.

Sriram Balasubramanian is an economist.