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Photo: iStock
Photo: iStock

India first needs a good market for bad assets

An ARC to take on the bad loans of our banks won’t get far without a functional market for these assets. To that end, we should let demand and supply determine how risks are shared

Among the figures that stood out in Monday’s budget tabled in Indian Parliament was the mere 20,000 crore set aside for the recapitalization of public sector banks (PSBs). Had our insolvency law been active and in fine fettle, it would not have been conspicuous. But covid stress among businesses big and small haunts the balance sheets of these banks, cramping their lending capacity should the stuffing get knocked out of their capital cushions by loans going bad. As forbearance ends, a significant fraction will. The latest Financial Stability Report of the Reserve Bank of India (RBI) expects the gross non-performing assets (NPAs) of PSBs to swell from 9.7% last September to 16.2% of advances by the end of 2021-22’s second quarter (under a baseline scenario). If the government manages to privatize a couple of PSBs before 1 April 2022, as it proposes to, then that will ease the burden somewhat. But the only explanation for our low PSB-recap outlay is the expectation of PSBs being relieved of impaired loans by what is loosely called a ‘bad bank’. This is the context in which the budget proposal of an asset reconstruction company (ARC) should be evaluated.

Details of what has been proposed, however, remain sketchy. The new ARC will house an asset management unit to manage and sell the toxic assets it acquires from banks, but this will cost money and the Centre has not budgeted any at all for its startup capital. Instead, PSBs and private banks are expected to put in the requisite funds. If the idea of an ARC holds appeal, though, it is because banks cannot rely on state bailouts forever. Nobody wants more good money thrown after bad. A weak economy coupled with reckless lending by PSBs, some of it dubiously inspired, has already cost our exchequer over 2.8 trillion since 2017-18. We cannot keep doing this. Yet, whether an ARC can resolve our credit crisis remains unclear, given that India still lacks a functional market for dud loans. The country saw a few ARCs created under the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002, but these have been of little help in relieving banks. Their basic aim was to securitize NPAs, and so they went about buying these from banks by paying mostly in ‘security receipts’ whose risk levels were derived from the same assets. In essence, originators of dodgy loans still found themselves lumped with default risk, which meant they had to block some capital for write-offs anyway. In 2016, an RBI order pushed banks to demand mostly cash for NPAs, hawked via auctions. This way, lenders could transfer almost all the risk of their stressed assets to NPA buyers. But ARCs, which were short of secondary buyers, balked at the minimum prices that banks asked for. The outcome: these assets found very few bidders.

Today, it is clear that a domestic market for NPAs is unlikely to function properly unless it achieves the structural flexibility needed to attract private participants from across the world. One suggestion is to redesign NPA auctions in a way that will balance and adjust the securities and cash components of every deal in accordance with actual conditions of supply and demand. This would imply a more equitable sharing of risks between banks and NPA buyers. It would also mean our lenders can’t really escape their risk exposure on NPAs. All said, better-managed banks are the only satisfactory solution.

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