Tag: loans

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.

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

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