Insights into Editorial: Bad loans: of desperate times and desperate measures

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Insights into Editorial: Bad loans: of desperate times and desperate measures

10 June 2016

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With over Rs.5.8 trillion worth bad loans lying with listed banks in India, it was felt that government’s intervention was much needed to solve the issue. In this regard, finance minister Arun Jaitley recently said that the government is planning to set up a stressed asset fund in association with banks that could provide equity or debt capital to stressed companies.

How is it different from an Asset Reconstruction Company (ARC)?

Unlike with ARCs, assets here would remain on the books of the banks. Whereas, ARC transfers the acquired assets to one or more trusts at the price at which the financial assets were acquired from the originator.

Details about the new stressed asset fund:

Much clarity is not yet available regarding the plan except that banks will not be the majority owners in such a fund.

Why setting up a new ARC would make a little difference?

Experiences so far say that setting up yet another ARC is pointless. There are a number of existing ARCs in the market, and many large global funds are planning to enter the segment. Among these, many are bank-sponsored ARCs. They have done little good because the banks and the ARCs have failed to agree on the price at which assets are to be sold. Besides, the recovery track record of ARCs has been modest at best.

Are there any alternatives?

  1. Vulture Fund or Special situations fund:

Such kind of funds buys equity or debt securities of distressed firms. However, this would be counter-productive and a conflict of interest. If such a fund were to operate independent of its bank sponsors, it would look to invest in distress assets at throw-away valuations. The bank sponsors would want to do the opposite and get the best possible valuations.

On the flip side, hypothetically, the bank sponsored fund could invest in assets at lower-than-justified prices and benefit from the upside that eventually comes from a turnaround in the stressed asset. This could be a conflict of interest if the management of the fund and the bank are not completely ring-fenced.

  1. A fund which specialises in providing working capital and short-term finance to these companies:

Though there is no bar on banks lending to assets that have been classified as non-performing assets (NPAs), Bankers, however, fear they will be questioned about extending financing to defaulters and stay away from such lending. Hence, this option looks feasible. A third-party fund can come in and lend to these stressed companies to help tide them over. But, there are existing non-banking finance companies (NBFCs) that have the capacity to do this should they choose to.

  1. Bad Bank:

There is also the option of setting up a bad bank like structure. However, experts have unanimously opposed this idea. Even the RBI governor has cautioned against it and the previous experience of IDBI’s stressed asset stabilisation fund suggests it does not work. Setting up a bad bank would be a massive moral hazard.

  1. Take a long route:

This option makes most sense but also involves the most pain. That is to take the long road towards resolving the stressed asset problem. This pile of Rs.5.8 trillion in bad loans has been created over years. Some of it is because of circumstances like stalling of infrastructure projects and falling commodity prices. Some of these will slowly come back to life as the cycle turns. Then there are the bad loans created out of poor lending decisions. Experts suggest, let the banks take the pain for those.

Conclusion:

Government has proposed to infuse Rs70000 in PSU banks. However, given the situation, this amount is grossly inadequate. Government will have to find a way to increase the capital it provides to state-owned banks. An upfront capital infusion, along with reforms to ensure its proper usage, is the best way to reduce the pain of the bad loan clean-up.