Proposed solution

In a bid to tackle the growing bad loan problem in India's banking system, the Reserve Bank of India has issued a proposal to set up an institution called a bad bank—a private or state-owned public asset reconstruction agency that would buy up bad debt from banks. In a recent column, T.T. Ram Mohan, a professor at IIM Ahmedabad, talked about the real purpose of such an institution. "The bad bank will manage these NPAs (non-performing assets) in suitable ways — some may be liquidated, others may be restructured, etc. Getting NPAs off the books will help the PSB (public sector banks) management focus on new business instead of having to expend their energies on trying to effect recoveries. A bad bank will be better focussed on the task of recovery. If it is a private entity, it can also bring in superior expertise. It would appear that the bad bank concept has many things going for it", he said.

The RBI has come up with this idea probably with the understanding that many of its schemes—Flexible Refinancing of Infrastructure, Asset Quality Review and Sustainable Structuring of Stressed Assets, among others—have not produced the necessary results. Despite these schemes, the Indian banking system continues to be saddled with bad loans. Reports indicate that stressed assets now make up over 12 percent of the total loans in the banking system. The situation in public sector banks is far worse. Their stressed loans are at least 16 percent, which is more than three times than that of private banks. Also, these banks have posted a 56.4 per cent rise in gross non-performing assets or NPAs in 2016. Real credit growth is now negative, the lowest in over two decades. Many have posed the argument that under the current schemes introduced by the Central bank too much discretion is left at the hands of banks. Former RBI Governor Raghuram Rajan, however, was never a major votary of the idea. He argued that this approach would just transfer the bad loans from banks to another firm. The focus, he argued, should be on how to restructure bad loans.

Although the concept of a bad bank seems simple, implementing the idea is a whole another ball game. Deputy Governor Viral Acharya reportedly said that a bad bank could become an effective solution for the problem of bad loans, "if designed properly". There are very significant logistical and legal challenges involved in setting up a bad bank. Even then there is no guarantee that it would significantly solve the problem. In fact, creating an entirely new institution is not going to be an easy task and a time-consuming affair. Many details are yet to be worked out. The government, though, seems to be onboard. Reports suggest that the Ministry of Finance has backed the Central bank's proposal, saying greater urgency was needed to address the problems of bad loans that were stifling investment and growth. For the moment, banks may miss the Central bank's deadline to clean up their balance sheets by March 2017, since their efforts were redirected from recovering bad loans to implementing the government's demonetisation initiative.

The Centre's latest Budget provided Rs 10,000 crore for recapitalisation of public sector banks in 2017-18. Experts contend that this is markedly below the Rs 25,000 crore the government had set aside in the previous year. Banks are in desperate need for recapitalisation so that they can start lending to sound companies with smart business proposals, thereby kickstarting economic activity. The onus of repairing weak lenders with necessary capital lies only with the government. There are wrongdoers among the Indian business community who have raised the cost of borrowing for everybody by racking up bad loans, in cahoots with government-owned banks. The knock-on effect of these bad debts has been deleterious for the entire economy. It is imperative to note that the major loan defaulters are not the small or medium-sized businesses, but major multinationals like Reliance ADA, Vedanta, Essar, Adani Group, and the Jaypee Group, among others. For years, Indian banks, especially those in the public sector, have lent rather recklessly to large businesses without due diligence. Does the government have a plan to deal with these errant borrowers?