In what could be the revival of the idea of a bad bank, the Economic Survey 2016-17 has floated the idea of a centralised Public Sector Asset Rehabilitation Agency to resolve the banking sector’s bad asset problem.
The Survey states that the simultaneous phenomena of companies turning overleveraged and banks being encumbered with bad loans have resulted in a ‘twin balance sheet’(TBS) problem, a legacy of the boom years around the global financial crisis. TBS had initially seemed to be a problem that would solve itself with the setting in of an economic recovery. However, the elusiveness of a recovery has exacerbated the problem to an extent where it could hinder growth, the Survey notes.
“To avoid this outcome, a formal agency may be needed to resolve the large bad debt cases – the same solution the East Asian countries employed after they were hit by severe TBS problems in the 1990s. In short, the time may have arrived to create a ‘Public Sector Asset Rehabilitation Agency’,” says Chapter 4 of the Survey.
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According to the Survey, so far, public discussion of the bad loan problem has focused on bank capital and funding requirements of public sector banks. “But securing funding is actually the easiest part, as the cost is small relative to the resources the government commands. Far more problematic is finding a way to resolve the bad debts in the first place,” it says.
The Survey says while there are cases where debt repayment problems have been caused by diversion of funds, the vast bulk of the problem has been caused by unexpected changes in the economic environment and growth rate assumptions going wrong.
Resolution is complicated by the fact that much of the debt is concentrated in large companies and such cases are “inherently difficult to resolve.” Cash flows in large stressed companies have been deteriorating over the past few years and resolution may involve large write-downs.
The Survey notes that banks face severe coordination problems while attempting resolution, since large debtors have many creditors, each with different interests. They find it difficult – financially and politically — to grant sizeable debt reductions, or to take them over and sell them.
“Since banks can’t resolve the big cases, they have simply refinanced the debtors, effectively “kicking the problems down the road,” the Survey states, adding that the process increases the costs to the government since bad debts of state-owned banks keep rising, and those to the economy by hindering credit, investment and, therefore, growth.
The Survey says that private asset reconstruction companies have barely been 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.”