Tag: Economic survey

Is there a case for a bad bank?

Banking & Finance

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The economic uncertainties from the Covid -19 pandemic has once again re-opened the debate on the need for setting up a bad bank to take care of the fresh wave of bad loans and also free up resources for lending.

While the Finance Ministry is understood to be examining such a proposal, Reserve Bank of India Governor Shaktikanta Das also recently said the central bank is open to look at such a plan.

Significantly, the Economic Survey 2020-21 has been silent on the issue of a bad bank but has pointed out the need for an asset quality review after the current forbearance ends and a re-capitalisation of banks to spur lending.

All eyes are now on whether Finance Minister Nirmala Sitharaman will announce such a plan in the Union Budget 2021-22 or will look at other ways to resolve the challenges in the banking sector.

The RBI in its latest Financial Stability Report has estimated that the gross NPAs of banks may increase from 8.5 per cent in March 2020 to 12.5 per cent by March 2021 under the baseline scenario and the ratio may escalate to 14.7 per cent under a very severely stressed scenario.

This is already becoming evident in the third quarter results of banks that reflect increased stress and lenders are gearing up to meet a fresh wave of NPAs.

 

HDFC Bank had said if it had classified accounts as NPA after August 31, 2020, the proforma gross NPA ratio would have been 1.38 per cent as on December 31, 2020 as against reported 0.81 per cent.

For Yes Bank, the proforma gross NPA would be nearly at 20 per cent as against the reported 15.36 per cent for the third quarter this fiscal.

In their pre-Budget interactions, setting up of a bad bank has been a key wish list for many stakeholders and experts. Industry chamber CII had urged the Finance Minister to consider such a proposal and allow multiple bad banks.

Explaining the rationale, veteran banker and CII President Uday Kotak had said, “In the aftermath of Covid-19 it is important to find a resolution mechanism through a market determined price discovery. With huge liquidity both globally and domestically multiple bad banks, can address this issue in a transparent manner and get the credit cycle back in action.”

Prashant Kumar, Managing Director and CEO, Yes Bank, also said it would be good for the economy. “We are the first ones to support the idea of a bad bank and we are working on our own ARC. I think a bad bank coming in any form would be really good for the economy,” he had recently told BusinessLine.

Analysts point out that a bad bank would lower the re-capitalisation need for public sector banks in the new fiscal year and boost incremental lending by banks.

Banks could become more cautious on lending if bad loans rise. The Survey highlighted that credit growth slowed down to 6.7 per cent as on January 1, 2021 from 14.8 per cent in February 2019.

Not a new idea

The idea of a bad bank is not a new proposal but has been revisited a couple of times in the last few years.

As the name suggests, a bad bank will buy the bad loans of financial sector entities so that they can clean up their balance sheets and move ahead with lending.

One such entity was set up in 1988 for US based Mellon Bank and other such agencies have been set up in countries including Ireland.

The proposal of setting up a bad bank in India had previously come up in the Economic Survey 2016-17, which had suggested setting up of a centralised Public Sector Asset Rehabilitation Agency (PARA) to take charge of the largest, most difficult cases, and make politically tough decisions to reduce debt.

In June 2018, then Finance Minister Piyush Goyal had set up a committee to examine whether transferring NPAs of PSBs to an ARC or a bad bank was a suitable proposal.

Many not in favour

But, there have also been many arguments against a bad bank, with reservations within the government and RBI at various points of time.

Funding could be an issue in a year when the government is hard pressed for resources. In its proposal submitted in May last year, Indian Banks’ Association had suggested an initial outlay of ₹10,000 crore.

But the main issue is that banks would have to sell the bad loans and take a haircut, which would impact its P&L. Until this issue is addressed, creating a new structure may not be as potent in addressing the problem.

A recent note by Kotak Institutional Equities had also said bad bank is perhaps well served in the initial leg of the recognition cycle.

“Today, the banking system is relatively more solid with slippages declining in the corporate segment for the past two years and high NPL coverage ratios, which enable faster resolution,” it said, adding that setting up such an agency today would aggregate but not serve the purpose observed in other markets.

As of now, the problem of NPAs are held at bay as the Supreme Court verdict is pending. Setting out a strategy to tackle the looming issue is critical – if not a bad bank, then via other options.

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Plan bad bank to whittle down and not transfer bad loans, BFSI News, ET BFSI

Banking & Finance

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Bad loans which were 7.5% in September 2020 threatens to exceed 13% by September 2021 due to large scale disruption caused by COVID-19. The gravity of the situation is expected to unfold and surface once the suspension of IBC is lifted and later when loans liberally restructured or advanced to pandemic stuck companies become due for repayment .

Evidently, status -quo is not sustainable any more. The recent measures for infusion of capital in Punjab and Sindh Bank through questionable means i.e. issuance of government bonds to the bank – interest free and on -hold to maturity basis without actual cash flow and against accounting norms -is a pointer towards emerging grim situation.

Many countries world wide including US, UK, Germany have in the past successfully set up bad banks particularly post the financial crisis of 2008 ,to hold and manage bad loans till the underlying assets are restored to health and / or disposed off or liquidated .Notable amongst these is City Holdings which successfully managed bad assets worth $800 billion hived off from City Bank .The objective of the bad bank is undoubtedly laudable and experience world wide reassuring . It however needs to be subjected to the test of realism in the Indian context.

Managing bad loans is a different ball game then lending. However, without recovery of loans, the lending has no meaning. Lending activity has to be seen as a value chain in continuum till outstanding loan is recovered and if found necessary, through take over and realisation of underlying assets or businesses. The banks therefore need to create requisite capacity to manage bad loans by themselves . A bad bank in the normal course would therefore be a moral hazard incentivising banks to continue with their indiscreet lending practices.

The Indian Bankers Association justified a bad bank amongst others for the reason of lingering fear of enquiries and investigations in the minds of bank officials for the commercial decIsions taken for restoration of viability or disposal of bad loans. This argument is preposterous as the bad bank sponsored by the government, Asset Management Company (AMC) and Alternative Investment Fund (AIF) setup as a public private partnership may not either be able to escape external scrutiny for public accountability. The banks should be made to assume rather than abdicate their responsibility for managing bad loans.

As a sound management practice, banks should set up a Strategic Business Unit (SBU) as part of its core functions, designed to segregate bad loans and ring fence resultant risks on the balance sheet to focus on management of loans at SMA 2 or NPA stage. The SBU should for the purpose have commensurate autonomy, organisation structure, system and processes. Through SBU set up in 2003 as a part of Internal restructuring Dresdner Bank AG ,Germany ,was able to successfully resolve €35 billion portfolio. In case of banks with high level of NPAs ,the government can consider giving on- balance guarantee to protect the bank from loss on bad portfolios.

Pandemic has however created extraordinary situation with crippling effect on the economy in general and on solvency and liquidity of industry – across the board, in particular. It is akin to a force majeure event – not caused by actions of banks or the borrowers. The banks in order to ensure their continuing viability of operations and ability to meet financing needs of the trade and industry post pandemic need to be freed of burden of NPAs through on balance sheet or off balance sheet structures with the government support.

The Bad bank should better be set up as spin-off i.e. disposing bad loans into a legally separated entity and not as a special purpose vehicle used to off -load bad loans. On balance sheet structures though desirable may not be as efficacious given the urgency to tame and deal with the NPAs caused by the pandemic.

Further it would be advisable that government instead of setting up one monolithic bad bank , should set separate bad bank for infrastructure loans and for other loans. This would enable focused approach considering economic significance and specialised skill set required in nurturing, disposal or liquidation of underlying assets. Different bad banks can then be weaved in to a holding company structure for better governance and uniform approach, in managing bad loans. Transfer of bad loans should be at fair value for reflecting true financial health, and not at book value as mooted in some quarters. It would be imprudent to Tweak or overrule, through legal or regulatory diktat, internationally accepted accounting norms in this regard.

The government instead of setting up one monolithic bad bank , should set separate bad bank for infrastructure loans and for other loans .This would enable focused approach considering economic significance and specialised skill set required in nurturing, disposal or liquidation of underlying assets. Different bad banks can then be weaved in to a holding company structure for better governance and uniform approach.

The bad bank may offer a viable alternative structure as an extraordinary and onetime measure .It should however be confined to bad loans caused by pandemic the principle followed for granting moratorium for repayment of loans or suspension of IBC post pandemic.

Care should also be taken that the bad bank does not become a mere instrument of transfer of bad loan from one balance sheet to another. Learning from international experience the bad bank need to be fully autonomous, professionally managed and have systems and processes which facilitate initiatives and outcome oriented actions in a fair and transparent manner. This is a tall requirement in Indian context .However if not addressed before launch, the bad bank may remain bad causing irreparable distress in future.

Dr. Ashok Haldia, Fmr MD & CEO, PFS


The blog has been authored by Dr. Ashok Haldia, Former MD & CEO, PFS.

DISCLAIMER: The views expressed are solely of the author and ETBFSI.com does not necessarily subscribe to it. ETBFSI.com shall not be responsible for any damage caused to any person/organisation directly or indirectly.



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