It may give a short breather, but it will not address the underlying causes responsible for such huge levels of NPAs, particularly in state-owned banks
The banking industry in India is dominated by Public Sector Banks (PSBs) which are owned by Govt of India. As on 2020, PSBs account for 60% of the total bank loans as against the loan portfolio of private sector banks of 36%. These banks have a market share of 64.75% of the total deposits while as private sector banks have a share of 30.35% of the total deposits. In view of their dominant place in the banking sector, the role of public sector banks in the growth and development of Indian economy is of great significance.
However, these banks will be able to play their expected role only when these are able to mobilise more savings and at the same time are able to channelise the accumulated funds towards investments in an efficient manner. But so far, public sector banks in India have been found to have largely failed to park their funds in the hands of those who are credible and competent to use the borrowed funds to generate sufficient economic gains for themselves and consequently for the economy as a whole. The failure of public sector banks is evident from their bulging Non-Performing Assets (NPAs). As of March 31, 2018, provisional estimates suggest that the total volume of gross NPAs in the economy stands at Rs 10.35 lakh crore, of which 85% belongs to public sector banks. The RBI Governor has warned that most likely the bad loan ratio of banks in the country is going to almost double this fiscal year.
NPAs are part and parcel of the banking business but when these NPAs reach unmanageable levels, it is a serious concern both to the banking industry and to the economy as a whole. Apart from having an adverse impact on the operating performance of the banks, it limits their lending capacity, which in turn acts as a constraint to investment in an economy, thus limiting economic growth. The Standing Committee on Finance released a report on the banking sector in India where it observed that banks’ capacity to lend has been severely affected because of mounting NPAs. To address this and other problems, Govt of India has taken a number of steps during the past few years. Post 2014, the Govt of India has established three debt resolution mechanisms. The Strategic Debt Restructuring (SDR) scheme of 2015 allowed creditors to take over firms that were unable to pay back loans and sell them to investors to realise their dues. In 2016, the government came up with Sustainable Structuring of Stressed Assets which allowed creditors to take 50% hair cut with a purpose to restore the financial viability of the stressed businesses. The most prominent step was the enactment of Insolvency and Bankruptcy Code (IBC) in 2016. Under IBC, an insolvency professional will preside over the insolvent accounts to decide whether to restructure the loan account or to sell the defaulters’ accounts to recover the borrowed funds. All this is done in a time-bound framework of 180 days. Due to the serious economic overhang happening due to covid-19 pandemic, the IBC has been stopped from initiating fresh NPA restructuring process until March, 2021, on the orders of the apex court.
The first two mechanisms had failed by 2017, the reasons of which have been explained in the Economic Survey of 2016-17 at length. So far, the performance of IBC also has not been noteworthy.
To deal with the bulging problem of NPAs of public sector banks, the union budget 2021 has announced the creation of a “Bad Bank”, which has been hailed by many in the country. However, public sector bank unions have raised a hue and cry about the privatisation of some PSBs and the LIC as well as against the creation of the proposed “Bad Bank”. Therefore, the question arises, is the proposal of the Bad Bank a good idea or bad?
The proposed Bad Bank is actually an Asset Reconstruction Company (ARC) which will be set up together by state-owned banks and private sector banks without any equity contribution from Govt of India. The union government will be only providing sovereign guarantee needed to meet the regulatory requirements. The proposed bank will be established on ARC-AMC Model, under which ARC will take over the stressed assets from banks at a discount which will be then transferred to AMC at net value, i.e., book value minus provisioning done by the banks against these stressed assets, for resolution. In exchange of the stressed assets, the banks will get 15% in cash and the security receipt for the remaining balance of 85% of the value of stressed assets. Upon receiving the stressed assets, the AMC will restructure the loans, turn them around, and finally sell them to a potential investor or to an Alternate Investment Fund. The proposed ‘Bad Bank’ or ARC is estimated to absorb between Rs 2 lakh and Rs 2.2 lakh crore of NPAs.
The question is, when there are ARCs in existence, what prompted the government to create another such company by the name ‘Bad Bank’? According to the Ministry of Finance, the existing ARCs are thinly capitalised; as such, these are unable to absorb the huge stressed assets urgently lying with the banks. This constraint is being cited as a reason by the government for the creation of another ARC in the name of “Bad Bank”. This will help the banking sector to cleanse their balance sheets which in turn will help the banks to improve their profitability, as the banks no more will be required to do provisioning against the stressed assets. Besides, the banks will be no more bogged down in the management of stressed assets, and as such will be able to have greater focus on lending. It is also being argued by the Ministry of Finance that the ‘Bad Bank’ will be able to take faster decisions as it will be owned jointly by state-owned banks and private sector banks, which will ensure early recovery of the stressed loans.
But contrary to the official position, the All India Bankers Employees Association (AIBEA) has resented the creation of the ‘Bad Bank’. The association argues that the creation of ‘Bad Bank’ will only leave banks free from stressed assets, not fix the issues underlying these corporate borrowings. A number of people are apprehensive of the ‘Moral Hazard’ that the creation of this bank is likely to cause.
The proposed ‘Bad Bank’ is nothing but an addition of one more ARC dealing with the reconstruction of bad loans. It will certainly help to cleanse the balance sheets of the banks from all the stressed assets which in turn will improve their profitability. But the fact is that the creation of Bad Bank will only give a short breather. It will not address the underlying causes which are responsible for such huge levels of NPAs, particularly in state-owned banks, and thus it will fail to ensure greater accountability both of the banks and the corporate sector. It is a fact that many of the NPAs are partly due to the reckless lending by the banks and partly due to the misuse of borrowed funds by the lenders. It is in view of this fact that the government in 2016 undertook the much-awaited financial sector reform in the form of the enactment of IBC, which was hailed by all including the business fraternity. In our typical working environment we need to ensure greater accountability of the financial sector and at the same time resolve the bad debt problem while providing a painless revival mechanism to corporate entities. All these and other objectives are very much embedded in the IBC. Besides, it would be unrealistic to assume that the creation of ‘Bad Bank’ would guarantee more lending to stimulate economic growth in the country.
Lending not only depends on the availability of funds with the banks but mainly on the consumption growth; therefore, until and unless the demand picks up in the economy, there is very slim possibility that the lending by the banks will pick up. The banks were flush with liquidity during the last few fiscal years but the credit take-off was subdued for two reasons. One, there was decline in demand in the economy, reflected in the declining GDP during the last two fiscal years. Second, with the enactment of IBC there was hesitance on the part of bank officers to take risks while lending to avoid harassment by regulators in case the loans turned bad.
The writer is former Registrar and currently Professor at Dept of Commerce, University of Kashmir. [email protected]