Home / Opinion / Columns /  It’s better to stop the creation of bad debt than set up a bad bank

On Saturday, I listened to the Nani Palkhivala Memorial Lecture that Shaktikanta Das, governor of the Reserve Bank of India (RBI), delivered. He was right to focus on the importance of financial stability and fiscal stability in his speech. In the Q&A session that followed his lecture, he said that RBI was open to considering any serious proposal on the setting up of a “bad bank". In principle, such openness is to be welcomed. However, it may be an option that the government need not have to exercise.

I wrote in these pages in December that too much rather than too little growth would be a challenge for India in the coming decade. In another column, I wrote that international capital inflows would be one of the main reasons for that. In the four weeks since I wrote those columns, developments in America only reinforce those conclusions.

There is no real healing in America, contrary to the superficial sentiments expressed about it. It’s no exaggeration that the US appears only a few short mishaps or mistakes away from a civil war. Its new government, notwithstanding all the stimulus of 2020, is promoting a $1.9 trillion fiscal stimulus. Although Federal Reserve Chairman Jerome Powell has denied fiscal dominance of monetary policy in America, that is the reality. Loose monetary policy will be in place for the foreseeable future. Not just in America, but elsewhere too in the developed world, fiscal and monetary policies are conjoined at the hip. Therefore, even though a long overdue recovery in the US dollar appears underway, the respite, if any, is likely to prove temporary. In all possible ways, America seems determined to test the limits of the exorbitant privilege its currency enjoys. In a very well-written long article (‘The dollar is dead. Long live the dollar’) in Foreign Policy, professor Adam Tooze opined that the dollar was a bit like democracy: It is the worst global currency, except for all the others. America appears to be on a path to prove this wrong.

The upshot of it is that India’s economic growth, unless pandemic risks resurface, should be good enough to largely take care of its non-performing assets (NPAs) in the coming years. After all, it was the high economic and credit growth of the 2003-08 period that whittled down the NPA ratio. T.T. Ram Mohan wrote in a well-argued article for Business Standard that the provision coverage ratio at banks had gone up from 42% in 2016 to 72.4% in September 2020, and that net NPAs were down to 2.8% in March 2020. He is also right that the bad loan legacy is almost done with. Consequently, the bad bank is a right idea at the wrong time.

Instead, the government and the banking sector’s regulator should be focused on doing the following.

One, the government should reinstate the operation of the Insolvency and Bankruptcy Code (IBC). The code had improved the recovery rate from NPAs in the banking system. It is an important milestone in India’s journey towards a competitive economy with capital efficiency. We should not let an unseen virus derail it for too long. By all means, let us remove some of the weaknesses in the code revealed or created by court judgements. Let us also create disincentives for deliberate delaying tactics, so that the original timeline of 270 days is honoured more in its observance than in breach. The corporate sector appears to have fared far better last year than feared. Good for it. Time to reinstate the IBC.

As Ram Mohan argues, the government should provide more than adequate capital to the strong banks it owns, and adequate capital to the not-so-strong ones, with well-defined performance criteria for them to receive more; if they don’t deliver, then the government should consolidate them or begin diluting its stake below 51% in such banks. Then, the government should level the regulatory playing field between private-sector and government-owned banks. The risk management and compliance culture in public-sector banks must improve, but equally, they should not be subject to excessive oversight by government investigative and audit agencies. More than these, there are two other important things that constitute the fountainheads of NPAs. The government has to plug them rather than expend its energy on setting up a bad bank.

The government should evolve a framework for passing on explicit development goals of the state for banks to achieve through the credit mechanism. The government should provide for them in the budget and compensate banks rather than direct credit by diktat. The cost of directed lending is not just the creation of NPAs, but morale and market-value erosion as well. In any case, recapitalization needs mean that the fiscal costs are not avoided. It is self-defeating.

Then, governments (Union and states) should plug the other underlying sources of NPAs. Among things, they should ensure economic pricing of utilities, honour power purchase contracts and raw material purchase agreements, pay arrears to private counterparties, and stop being reflexive litigants.

These would greatly help the country achieve high growth and sustain it. Setting up a bad bank may be unnecessary.

These are the author’s personal views.

V. Anantha Nageswaran is a member of the Economic Advisory Council to the Prime Minister.

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