NPA crisis at Indian banks is mostly because of bad loan concentration in this one sector

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Published: August 2, 2018 10:35:05 AM

The most intractable bad loans, the ones the bad bank is meant to deal with, are concentrated in one sector: power. In particular, Indian thermal plants are struggling.

banks, investmentsThe latest terrible proposal for dealing with the bad loans weighing down India’s PSU banks.

India’s government seems intent on abandoning good ideas for dealing with the country’s banking crisis and encouraging bad ones. Perhaps that shouldn’t be surprising, given that the bureaucrats don’t yet seem to have grappled with the real nature of the problem.

The latest terrible proposal for dealing with the bad loans weighing down India’s state-owned banks, which control more than two-thirds of deposits, is to create a “bad bank” — an asset-management company that would take stressed assets off their balance sheets. Naturally, the scheme emerged from a committee made up of the heads of India’s nationalized banks.

Ownership of the new company would be shared between banks and private investors. It would have to raise at least 1 trillion rupees (about $14.5 billion) for an alternative investment fund from various pools of capital in the private sector. Why so much? Because the company will have to act as a market maker for stressed assets that nobody wants, picking up 15 percent of an agreed-upon floor price.

This is the real issue. There are already quite a few private-sector asset-management companies lurking around now that India has finally instituted a real insolvency code. The problem isn’t that they don’t have enough money, it’s that not enough of the stressed assets being put on sale look good enough to buy.

The most intractable bad loans, the ones the bad bank is meant to deal with, are concentrated in one sector: power. In particular, Indian thermal plants are struggling. A parliamentary subcommittee estimated earlier this year that 34,000 megawatts-worth of capacity is in trouble. Either nobody has signed up to buy power from these plants, rendering them unprofitable, or they don’t have access to subsidized coal.

An industry association thinks that the real number is closer to 50,000 megawatts, in the same ballpark as all the capacity added in the past five years of feverish plant-building. Others have provided even higher estimates. This is a significant proportion of India’s total power generation capacity — and, at perhaps 4 trillion rupees, a sizeable fraction of the banks’ balance sheets.India isn’t alone. In several countries, analysts are beginning to wonder if “stranded assets” — in particular, thermal capacity left behind in the shift to renewables or to more efficient generation — threaten to create systemic stress for the financial system. One estimate suggests that European financial institutions alone, including pension funds, have more than 1 trillion euros of exposure to fossil-fuel companies and projects, and even a smooth transition to a low-carbon economy might involve losses of 400 billion euros. Worse, it isn’t always certain who’s exposed to what degree — the exact circumstances in which sudden crises can take hold. In the U.S., meanwhile, coal companies are returning to the leveraged-loan market with a vengeance; fossil-fuel assets already made up a third of that market in 2015.

In India, renewable energy now looks competitive with “zombie” thermal power plants in terms of cost, while new plants require government subsidies and favorable administrative decisions that bureaucrats are reluctant to provide. In addition, provincial power utilities are chronically in the red because of their inability to force end-users of electricity to pay up. Even if they recover, and more and more Indians get access to electricity, a decent proportion of the investment in the sector is going to go into renewables or clean coal.

Those stressed assets that have been — or are likely to be — rehabilitated seem to be in sectors like steel, where recovering domestic demand in India (and some handy antidumping tariffs targeted at China) have convinced some investors to take a punt on a plant or two. By contrast, there are no takers for plants, like one $38 billion white elephant in Jharkhand, that were only profitable if the government subsidized their coal. Private Indian power plants are in any case operating at only 55 percent of capacity; who would want to risk setting up another one?

The transition to a lower-carbon economy is a reality, even for countries like India where coal will still be the bedrock of power generation for decades to come and even if renewable energy is still unreliable for base-load power. Given that this transition is real and happening, policymakers around the world must understand that carbon-based assets are a financial time-bomb. In India, they look like they might torpedo the banking sector; elsewhere, they will pose other major threats to financial stability. It’s time for regulators to get serious about the knock-on effects of the world’s fight against climate change.

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