The problem of bad loans in India has been festering like a sore for several years. It is now being recognised by the government as an urgent issue that needs a quick resolution.
The problem of bad loans in India has been festering like a sore for several years. It is now being recognised by the government as an urgent issue that needs a quick resolution. To my mind, this is the single-biggest economic issue that needs to be resolved. It has been holding up private investments and is likely to choke any growth in demand and jobs in the economy. It has also clouded several constructive measures taken by the current as well as the previous governments for inducing corporate demand.
There are three steps in the framework to systematically resolve the bad loans problem.
w Identify the reasons that led to the bad loans problem. There are systemic and specific reasons for banking loans turning into non-performing assets (NPAs), and these require different approaches to the solution. Here I deal only with systemic reasons.
w For systemic reasons, policy-makers need to develop appropriate solutions with the sole objective of getting the maximum sustainable benefit to the broader economy. Each solution would have its costs and benefits to various stakeholders. Hence, there should be a clarity, in advance, as to what is expected of the solution.
Building the buy-in of the stakeholders and a swift implementation of the proposed solution.
Reasons for bad loans
There are principally two system-wide factors that have led to the bad loans problem. First, the exuberant level of leveraged growth in the corporate sector post the global financial crisis (GFC) was not supported by a rigorous “what if” analysis by the investors. In hindsight, the majority of affected corporates and banks failed to swiftly develop and implement a strong alternate plan to deal with a sharply changed environment and thereby protect their risk capital.
Second, there have been significant and unanticipated developments in the regulatory and policy environment. The changes have been brought in by the governments as corrective measures to ensure long-term transparency and efficiency in the core sectors of the economy. However, it can be argued that these changes needed to be supplemented with other measures which could have ensured a smoother cycle of transition. The central and state governments failed to timely enact and implement supplemental laws/policies to protect the prevailing contracts surrounding the operation of sunk-in investments. The stalling of a significant portion of large private sector projects could be directly linked to cancellations of existing contracts, delays in award of fresh contracts, and delays in implementation of supportive policy measures.
While the bad loans problem involves banks, corporates and the government, the former had very little leeway to act in the absence of the enabling policy steps by the latter.
RBI has come up with several measures (5/25, S4A, Strategic Restructuring) to get the lenders and borrowers work towards resolving bad loans. However, for these measures to work, it was essential to have strong corrective policy measures swiftly enacted by the government.
For long, policy-makers have failed to realise the critical importance of a stressed asset market. The absence of adequate capital and effective competition in private markets represented by Asset Reconstruction Companies (ARCs) and the environment of post facto investigations of transactions by government agencies has further constrained transactions.
The proposed solution
A solution needs to be developed keeping in mind the reasons behind, and the prevailing circumstances surrounding, the bad loans problem, as presented above. Since the factors have largely emanated out of the unprecedented regulatory and policy changes, the government must step in as the principal “rectifier” of the problem. Also, it would be very much within the domain and the interest of the government’s wider role to restart the overall economy by strengthening the balance sheets of the corporates and lenders.
This would mean, basically, that a national ARC be formed to buy a significant part of the stressed assets. The price of the assets can be determined by an independent panel, to be accepted by all the parties. The role of the government should be to facilitate, or even buy, the stressed assets at a fair price. While the above suggested measure may appear to be drastic, at least going by the theory of incentives, it is actually not so, if done in a transparent manner.
In terms of benefits by adopting this approach, private investments will get an immediate boost, leading to demand and job creation. The government can also, in all likelihood, benefit from the improved valuations of the bought out loans in due course. The proposed solution is not without precedence. It has similarities to the SUUTI framework implemented earlier.
It is imperative that the government acts fast and decisively on the issue. The political dimension of any approach to resolution that involves government capital is likely to be also an important factor. However, with the right framework of communication and implementation, it would indeed be in the interest of the government to move forward and realise the benefits of a corporate and banking sector revival.
The author, Hemant Manuj, is associate professor, Finance, SP Jain Institute of Management and Research (SPJIMR)