Modi Adviser Says Bad Bank Not Needed to Solve Loan Mess

  • Enough asset reconstruction cos to buy bad loans, top adviser
  • State banks will need bigger capital infusion than planned

There is no need for India to set up a new state-run fund manager to resolve the world’s highest stressed assets ratio as it already has institutions that can deal quickly with the problem, a top government adviser said.

Creating such an entity, a so-called bad bank, “can easily result in the loss of valuable time, perhaps as much as a year,” said Arvind Panagariya, vice chairman of Niti Aayog, the government’s top policy planning body, in an interview. “There are in existence four or five reasonably-sized asset reconstruction companies plus there is a State Bank-run ARC, which we can further strengthen. The latter can play a useful role in providing market discipline.”

As well as moving some larger non-performing assets out of banks, India also needs to recapitalize lenders and probably on a scale larger than previously anticipated, Panagariya said on Monday. Ridding bank balance sheets of bad loans is crucial to reviving credit growth and furthering Prime Minister Narendra Modi’s goal of creating more jobs in the $2 trillion economy.

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“There is no shortcut, no quick and easy way out of this bad-loan mess. Hard choice is the right choice here,” said Hatim Broachwala, a Mumbai-based banking analyst at Nirmal Bang Institutional Equities. “Strengthening the ARCs further in terms of capital and regulatory frameworks and selling the assets to them seems to be the right solution.”

Stressed assets -- that comprise bad loans, restructured debt and advances to companies that won’t be able to service the debt -- have risen to about 16.6 percent of total loans, government data shows. The proposal for a state-run bad bank to resolve the problem was mooted by Arvind Subramanian and other advisers to the finance minister in India’s annual Economic Survey in January.

State-run banks will need more than the 700 billion rupees ($11 billion) that the government planned to infuse under a revamp plan proposed in 2015, Panagariya said. “Since then, the scale of NPAs has grown,” he said.

Past attempts to solve the problem by injecting cash into banks to boost their capital buffers haven’t led to a revival of loan growth. The task has been partly complicated by an economic slowdown and a reluctance to lend at state-run banks, which accounted for 80 percent of bad debt in the system last year.

Action Plan

The largest asset reconstruction companies in the country are run by Edelweiss Financial Services Ltd., JM Financial Ltd. and Kotak Mahindra Bank Ltd. Brookfield Asset Management Inc., Canada’s largest alternative asset manager, has set up a joint venture with State Bank of India to invest in stressed assets in the Asian nation.

According to a proposal mooted last month by Niti Aayog in a draft of its three-year action agenda, the government should support the auction of larger non-performing assets to private ARCs and bolster the State Bank of India-led ARC. The government is yet to provide details on implementation.

Banks can auction bad loans to asset reconstruction companies by offering them a 20 percent stake to ensure that their own returns are maximized if the soured debt is resolved closer to face value, Panagariya said. 

“This way, the ARC will have enough skin in the game to resolve the asset,” said Panagariya, a professor of the Indian political economy at Columbia University. “Since 80 percent stake would remain with the banks, we would minimize the possibility of allegations that the banks parted with the assets at a throw-away price.”

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