Government Revives ‘Bad Bank’ Talks... Reluctantly.

The Indian government has revived discussions on setting up a ‘bad bank’ as non-performing assets on the balance sheets of Indian banks remain elevated and may rise as a result of the Covid-19 pandemic. While discussions have taken place, hurdles and reservations to the setting up of a bad bank remain.

The Ministry of Finance has held informal discussions with the Indian Banks’ Association recently with “various permutations and combinations” on setting up a ‘bad bank’, a senior Indian Banks' Association executive said on the condition of anonymity. The government, however, is still reluctant to put in direct capital. It is also not keen to act as promoter of a ‘bad bank’, which, if approved, could take the form of a National Asset Reconstruction Company, as proposed by the IBA, the person cited above said.

Alternative options on table are to set up sector-specific special purpose vehicles, bank-led bad banks and an ARC collectively owned by lenders, according to the person cited above.

A Finance Ministry spokesperson didn’t respond to an e-mail questionnaire sent on Friday.

In December, Economic Affairs Secretary Tarun Bajaj had said the government would consider all options, including a bad bank, to improve bank balance sheets. On Saturday, Reserve Bank of India Governor Shaktikanta Das said the regulator was open to the idea if it is proposed.

Why The Idea Is Back On The Table

A “bad bank” essentially helps banks clean up their balance sheets by transferring the bad loans to an entity structured as an asset management company or an asset reconstruction company. This could potentially help improve credit flow to the economy.

The idea, which has been discussed and shelved many times over the past few years, has been brought back to the table as bad loans could rise once again from already elevated levels.

According to the RBI’s Financial Stability Report released last week, the gross bad loans in India could jump 13.5% in September 2021 from 7.5% in September 2020. The gross NPAs for state-owned banks will rise to 16.2% in September 2021 from 9.7% in September 2020.

The IBA has proposed setting up a national-level ARC with the government pumping in capital of about Rs 10,500 crore into the entity. According to the IBA’s proposal, banks would transfer their stressed assets at nominal book value to the ARC. The government’s backing will give state-owned lenders the confidence to do so without attracting the scrutiny of investigative agencies. This entity will buy the bad loans in return of security receipts and the assets would be managed by professionals till they are sold off.

However, the government doesn’t want to infuse capital into an ARC at the moment, the person quoted above said.

Read: Indian Lenders Pitch ‘Bad Bank’ Idea To Government Once Again

Another model being discussed is to allow banks to set up their own internal loan restructuring units. The government has experimented this in the past with IDBI Bank Ltd. when a Stressed Asset Stabilisation Fund — an SPV — was set up in 2004 to acquire the stressed and bad loans of the then state-owned bank. The government provided Rs 9,000 crore towards it (for the equivalent amount of stressed assets to be hived off) which was invested in government securities, redeemable in 20 years. But the SASF was able to recover only about Rs 4,500 crore till 2015-16, over a decade after it was set up, according to the Parliament’s Public Accounts Committee report of December 2018.

“Instead of creating a sector-specific SPV, I would suggest establishing a mother AMC which is sector-agnostic. One can always create a vertical within the AMC which can look into sectors specifically with the help of specialists in that area,” Yes Bank Ltd. Chairman Sunil Mehta, who chaired a government-appointed committee on resolution of stressed assets known as project ‘Sashakt’, said.

Mehta said the governance of the AMC should be “absolutely independent of the lenders” and the committee he chaired was of the unanimous view that the government should not hold a majority stake in the AMC which should be managed by professionals. “A government-led AMC or ARC will face the same challenges that any other public sector entity would face in terms of scrutiny of the investigative agencies. The government can certainly play the role of an anchor investor to give comfort to domestic investors and sovereign funds to come in. That’s why we had suggested that the public sector entities should hold up to 49% stake in the AMC or ARC,” he said.

While RBI Governor Das, over the weekend, said the regulator would consider a bad bank if it is proposed, former officials have taken opposing views on the matter.

Former RBI Governor Raghuram Rajan said a government-led bad bank could create a moral hazard. In contrast, D Subbarao, another former governor, had told news agency Press Trust of India in August that setting up a bad bank was “not just necessary but unavoidable".