Bad bank only a short-term solution for NPAs, structural reforms needed: Macquarie

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26 Aug, 2025 12:21

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The Economic Survey this year proposed a ‘bad bank’ to kickstart the resolution of non-performing loans in the banking industry. In theory,  a bad bank will take up the bad loans, leaving banks with a clean balance sheet, which in turn should allow them to raise capital when required. However, analysts, policy makers and even bankers are divided on the effectiveness of the idea.

Suresh Ganapathy of Macquarie Capital feels it is not a definite solution for the bad loan problem.

“It is a temporary stop gap arrangement,” Ganapathy told Moneycontrol. For a long-term solution, the government needs to bring about structural reforms, he says.

An easier solution would be for the government to infuse capital into state-owned banks. But that looks unlikely, given the government's own balance sheet problems.

In its newsletter GREED & fear, CLSA’s Christopher Wood says: “It seems that the Modi government’s strategy is to leave the state-owned banks to address their problems by natural attrition.” This is partly driven by the government’s reluctance to reduce its holding in PSUs below 50 percent, Wood says, adding that this would work to the advantage of  private sector banks.  A view which Ganapathy too holds.

“In the current scenario, private banks have an edge over the PSUs with stronger balance sheets and better earnings opportunity,” he says.

Recovery of loans remains one of the major challenge for PSUs. Alongwith with low recovery rate, problems of bureaucracy and legal issues makes recovery difficult for banks.

Ganapathy doesn’t expect defaults on restructured loans to increase in a big way, but cautions that resolution continues to look weak and will be slow.

The current tools like S4A have not done much. Also, the disconnect between the bankers and asset restructuring companies (ARCs) has prolonged the situation and led to a pricing dispute between the two.

“The predominant attitude of bankers towards ARCs is that they only do asset stripping and are getting their management fees and have little contribution towards operational restructuring or turnaround of the company,” Macquarie says in its ‘India Banks/Financials: Waiting for Godot… Where is the recovery?’ report.

From the private equity viewpoint, bureaucracy bottlenecks and slow implementations makes things difficult for ARCs.

Slow credit growth is another issue for the banks. “Credit growth is likely to remain muted as no capex demand for new or existing projects is visible,” Ganapathy said.

Currently, the credit growth in the industry has fallen from double digits to sub-5 percent. For FY18E, credit growth is expected to be around 8 percent.

Shift to IFRS, the new accounting standard from next fiscal, will add to PSU woes. IRFS includes three parts – a new expected credit loss (ECL), new guidance for classification and measurement of assets and liabilities and changes in hedge accounting.

The main impact will be from change in ECL, where till now the Reserve Bank used to prescribe provisioning on the basis of age of the stressed asset.

Under IFRS, banks will have to provide for losses it could incur from the NPL, which could push-up the provisioning. “It could impact 40 percent on net worth due to scale-up in provisions,” Ganpathy said.

Given the current scenario, it is advisable to stick with banks with strong balance sheet and good earnings probability, according to Ganpathy. Macquarie’s top picks include HDFC Bank, IndusInd Bank and Yes Bank.