Opinion | A debt recast should go along with bank reforms
Businesses that were doing fine before the covid crisis struck deserve to have their loans restructured. But we should also initiate a rehaul of India’s banking sector to strengthen it
The deferment of loan repayments allowed to companies as part of the Reserve Bank of India’s (RBI) moratorium has merely kicked the can down the road. For now, borrowers don’t have to worry about paying back lenders. But as soon as this special programme ends on 31 August, borrowers will be lumped with huge bills. To pay off their bunched up liabilities, they may need fresh credit or new terms. If loans are not rolled over, many of them might default. Thankfully, there’s a plan in the making to avert such a crisis up ahead. Finance minister Nirmala Sitharaman recently said that her ministry is in talks with RBI to allow a one-time restructuring of debt, so that businesses that were viable before covid-19 struck are able to survive the pandemic’s fallout on the economy. Such a reprieve may be necessary. The only questions relate to the details. What criteria would determine which debtors are deemed solvent? To what extent will the government aid banks whose capital buffers get overstretched? And how should the banking sector be reshaped to prevent recurring bad loans?
That many businesses would have been doing fine had it not been for coronavirus is beyond dispute. Unfortunately, even if the economy were to fully reopen after our prolonged lockdown, revenues will take a long time to recover, putting firms at threat of collapsing under the weight of their fixed costs. Since they suffered a simultaneous blow, their mounting debt repayments could exceed their ability to service debts all together, and in huge numbers. Under normal circumstances, banks could have taken recourse to India’s bankruptcy resolution mechanism. But this lies suspended for the rest of the year, and even after it is back in force, market conditions may be so weak that banks would be unable to extract sufficient value from the assets they take over. They would still have to log large write-offs. Barring a few exceptions, Indian banks were already overloaded with dud loans before the covid crisis. Without timely intervention by RBI and the government, the sector could potentially be staring at a blowout. Independent forecasts suggest that its bad loans could shoot up to 13-14% of all advances in 2020-21 from an estimated 8.5% last year.
The proposed debt recast programme must make its selection criteria clear. Businesses that deserve to fail should be allowed to. This would let resources be redeployed to more productive enterprises, a process termed “creative destruction" by economist Joseph Schumpeter. Viable debtors, meanwhile, could be offered relaxed terms on their liabilities, with the government bearing the cost. Eligibility conditions need to be set carefully. If these are too tough, even good businesses could get left out. On the other hand, if they are too loose, undeserving firms may end up getting rescued by public funds. The exchequer, of course, would need to be generous. No matter how much public money is put into the exercise, however, the banking sector’s underlying weaknesses are such that its perennial problem of bad loans may stay unresolved. The sector is over-dominated by the State. Since it is now an even bigger instrument of state policy than it was pre-covid, this structural pattern seems unlikely to change in a hurry. Yet, state-owned banks need not function like state-run banks. If the Centre held them through a stake-holding company, one that is accountable for their results, they may perform better. It’s time to move to an indirect model of ownership that grants them greater autonomy in pricing risks. Get this right, and banks won’t need bailouts.
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