In the frenzied summer of 2008, after the predictable collapse of Bear Stearns but slightly before the epochal meltdown of Lehman Brothers, Tim Geithner, who was then treasury secretary of the Federal Reserve, had proposed having the United States government guarantee the debts of all U.S. banks. The plan was immediately shot down as politically untenable, especially in a climate surcharged by a tea party on the ascendance, Had that plan been put into motion in a timely manner, the global economy would not have had to deal with the incredibly far-reaching consequences of that failure. India is similarly poised at a critical juncture in its financial history.
A nearly month old report by CRISIL lays out the sheer magnitude of the problem facing the Indian banking industry. The report estimates that gross Non Performing Assets(NPAs) will rise by almost 20 per cent to Rs 4 lakh crore during the current fiscal year. As a ratio to total assets, they will increase by about 20 basis points to 4.5 percent. The report also estimates that “weak” assets, which include NPAs as well as some proportion of restructured assets, will come in at Rs 5.3 lakh crore during the year, about six percent of total assets. Instead of being sharp, alert and focussed in tackling this problem, the combined Indian banking industry is content in slumbering onwards without addressing root causes. The economist Henry Blodget and Christopher Wood have argued that troubled banks with toxic NPAs can be fixed in a tried and tested manner which in economic parlance is referred to as the Swedish model.
Under the Swedish <g data-gr-id="51">model</g> banks were nationalised, fully aligning the interests of the institution with that of the <g data-gr-id="50">taxpayer,</g> while the depositor was fully protected. In the <g data-gr-id="47">process</g> shareholders were in effect wiped out, as they should be, and incumbent management was replaced, as it should be. Given that most of the Indian banks are already nationalised the central banker which in this case is the RBI(Reserve Bank of India) has to go one step further and write down the value of bank’s assets to nuclear winter levels. Banks performing poorly must be then recapitalized.
This is one way in which the perverse unintended consequences currently facing the Indian banking system be avoided. The best thing the RBI can do right now is to ensure that the financial health of public sector banks (PSBs) does not deteriorate further. The sanction of big loans should be outsourced to a group of professionals who should be directed to follow the appraisal process practised by leading private sector banks. In fact, the top management in PSBs should not hesitate to approach their private sector peers in order to learn best management practises. The RBI’s circular called a Strategic Debt Restructuring Scheme issued to all scheduled commercial banks is a step in the right direction. It suggests several manifold solutions to the looming crisis. In some cases, defaulting borrower companies may not be able to come out of stress due to operational/ managerial inefficiencies despite substantial sacrifices made by the lending banks. In such cases, change of ownership will be a preferred option.
With this principle in view and also to ensure more ‘skin in the game’ of promoters, JLF/Corporate Debt Restructuring Cell (CDR) was asked to consider the following options when a loan is restructured. A possibility of transferring equity of the company by promoters to the lenders to compensate for their sacrifices would be a good move as well. Promoters being compelled into infusing more equity into their defaulting companies is another suggested move. The last move suggested by the circular is the transfer of the promoters’ holdings to a security trustee or an escrow arrangement till turnaround of <g data-gr-id="36">company</g>. This will enable a change in management control, should lenders favour it. These are steps in the right direction but a lot more needs to be done. Incremental reforms would be a good place to start if big bang reforms do not seem possible due to policy constraints.