Economic Survey pitches for bad bank-like solution to tackle NPA

Beena ParmarMoneycontrolBanks and stressed companies get yet another variant - Public Sector Asset Rehabilitation Agency (PARA) - to resolve bad loan problems. But will it be successful?The Economic Survey on Tuesday said that the legacy of the historic mid-2000s investment boom was a curious combination of both twin balance sheet (TBS) and growth. TBS is when companies over-expand during a boom, leading to over leveraging funds which they cannot repay and hence, default on their loans or debts which impair the banks’ and their own balance sheets. Previously, the Reserve Bank of India (RBI) had carved out various asset resolution mechanisms starting with Corporate Debt Restructuring (CDR) set up in 2001 that allowed banks to help ailing companies with further funds based on majority decision. The central bank later released the Joint Lenders’ Forum (JLR) to empower the smaller lenders, Strategic Debt Restructuring (SDR) in 2015 that allowed lenders to take management control and convert their outstanding loans into a majority equity stake. This was followed by a flexible refinancing under 5:25 scheme and the S4A or the Scheme for Sustainable Structuring of Stressed Assets, where RBI facilitated account-wise bifurcation of healthy and unhealthy portions of a debt. However, the above mechanisms have proved to be a damp squib due to various factors like severe coordination problems, lenders not being able to find a buyer, no mutual pricing, time consuming process for debt to equity conversion, non-cooperation from borrowers and fractured legal framework.  Additionally, private Asset Reconstruction Companies (ARCs) haven’t proved any more successful than banks in resolving bad debts. “But international experience shows that a professionally run central agency with government backing – while not without its own difficulties -- can overcome the difficulties that have impeded progress,” the Economic Survey pointed out. PARA, a bad bank like structure is an attempt to solve this problem. A bad bank is a government-driven asset reconstruction company where banks can park their stressed assets. While this helps relieve individual banks from the pressure of stressed debt, the system as a whole still needs to provide enough capital provision against the bad loans. PARA would be charged with working out the largest and most complex cases. Such an approach could eliminate most of the obstacles currently plaguing loan resolution. "It could solve the coordination problem, since debts would be centralised in one agency; it could be set up with proper incentives by giving it an explicit mandate to maximize recoveries within a defined time period; and it would separate the loan resolution process from concerns about bank capital," the Economic Survey stated. Tried and Tested This idea has been tried a number of times across different economies including the East Asian countries in the 1990s. The US had set up the Troubled Asset Relief Program (TARP) or the Emergency Economic Stabilization Act of 2008, the UK government established the UK Asset Resolution, Ireland set up the National Asset Management Agency and Spain established an entity called ‘SAREB’ to which troubled and illiquid assets were transferred. The bad bank concept is not entirely new in India. When IDBI Ltd was turned into a bank in 2004, the government set up a Stressed Asset Stabilisation Fund (SASF) to hive off its stressed and bad assets worth Rs 9000 crore. This was done to help the bank focus on its core job and separate the recovery process to a separate division. According to a report by the Comptroller and Auditor General of India, SASF could recover only Rs 4,000 crore by the end of March 2013. Hence, this did not solve the bad debt or the recovery problem even as it helped create a good balance sheet. Raghuram Rajan opposed it Former RBI Governor Raghuram Rajan had opposed the bad bank idea suggesting that it would make sense for the banks themselves to recover the dues. According to him, in cases where loans are not priced appropriately when transferred to a “bad bank”, it could create issues. Further, he believed that the concept of a good bank and bad bank may not be relevant for India since much of the assets backing the banks’ loans are viable or can be made viable. Rajan said that though the concept of bad banks has not failed in other countries, “The complaint has generally been that it wasn’t done fast enough,” he had said in April 2016. However, the Economic Survey suggests that the issue for any resolution strategy – PARA or decentralised -- is not whether the government should assume any new liability. “Rather, it is how to minimize the existing liability by resolving the bad loan problem as quickly and effectively as possible. And that is precisely what creation of the PARA would aim to do.” With PARA, the Economic Survey says there are three major issues have bedevilled other agencies, and would need to be resolved to ensure a PARA would actually work as intended. 1. First, there needs to be readiness to confront the losses that have already occurred in the banking system, and accept the political consequences of dealing with the problem. 2. Second, the PARA needs to follow commercial rather than political principles. To achieve this, it would need to be an independent agency, staffed by banking professionals. 3. The third issue is pricing. If loans are transferred at inflated prices, banks would be transferring losses to the Rehabilitation Agency. Broadly, PARA would purchase specified loans (for example, those belonging to large, over-indebted infrastructure and steel firms) from banks and then work them out, either by converting debt to equity and selling the stakes in auctions or by granting debt reduction. This would depend on the professional assessments of the value-maximizing strategy.