The Bad Loans Problem: An Approach to a Solution
The issue of the bad loans (BL) problem in India has been festering like a sore for several years now. It is now being recognised by the Government, the Reserve Bank of India (RBI), and the influencers of public policy as an important issue that needs a fast resolution. To my mind, this is the single biggest economic issue that needs to be resolved by the policy makers today. This has been holding up private investments for several years and is likely to choke any growth in demand and jobs in the economy in the coming years. This issue has clouded the various constructive measures taken by the current, as well as the previous governments, for inducing corporate demand. Beyond the obvious economic dimension, there are dimensions of social and political impact as well.
Let’s evaluate a framework for resolution of the BL problem. There should be three steps in the framework to systematically resolve the BL problem.
1. Identify the reasons that led to the BL problem. There are systemic reasons and specific reasons for the banking loans turning into non-performing assets (NPAs), and these will require different approaches to the solution. Here I deal with the systemic reasons only.
2. For the systemic reasons, the policy makers need to develop the 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 clarity, in advance, as to what is expected of the solution.
3. Building the buy-in of the stakeholders and a swift implementation of the proposed solution.
Now I elaborate on the first two parts of the step. The third step is not covered by me in this article.
1. Reasons for the BL problem:
There are principally two system-wide factors that have led to the BL problem.
Firstly, the exuberant level of leveraged growth in the corporate sector post the global financial crisis (GFC) was not supported by an adequate level of "what if" analysis by the investors. It may be argued that there have been sharp and unprecedented regulatory and policy level developments in the last few years, adversely affecting the safety and returns of private investments. However, in hindsight, the majority of 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.
Secondly, as already observed, there have been some very 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 definitely be argued that these changes needed to be supplemented with other measures which could have ensured a smoother cycle of transition. The governments (mainly Central, but also State) have failed to timely enact and implement supplemental laws/ policies to enhance, or at least protect, the prevailing contracts surrounding the operation of the sunk-in investments. The stalling of a significant portion of the large private sector projects could be directly linked to the cancellations of existing contracts, delays in award of fresh contracts, and delays in implementation of supportive policy measures.
While the BL problem can be attributed to both the investors (including lenders) and the Government, the former had very little leeway to act in the absence of the enabling steps to be taken by the latter.
The RBI has come up with several measures to get the lenders and the borrowers to work towards resolving the bad loans. For instance, subventions were provided in the form of allowing more flexible rescheduling of project completions, and certain types of restructuring (5/25, S4A, Strategic Restructuring). However, these could have helped only as temporary measures, till the projects got back into fully operational mode. As a pre-requisite for these measures, therefore, it was essential to have strong corrective policy measures swiftly enacted by the Government.
Apart from the above, the policy makers failed to realise the critical importance of a stressed asset market, while urging the lenders and the borrowers to transact in stressed assets. Since there is a virtual absence of an independent price clearing mechanism, the banks are forced to agree to subjective prices for sale of stressed assets to either the Asset Reconstruction Companies (ARCs) or any other counterparty. The absence of adequate capital and effective competition in the private markets represented by ARCs and the environment of post facto investigations of the transactions by the government agencies has further constrained the transactions.
2. Proposed solution:
The solution needs to be developed, keeping in mind the reasons behind, and the prevailing circumstances surrounding, the BL problem, as presented above.
Since the factors, cited above, have largely emanated out of the difficult and unprecedented regulatory and policy conditions, it is imperative that the Government steps in as the principal "rectifier" of the problem. Secondly, it would be very much within the domain and the interests of the government's wider role to restart the overall economy by strengthening the balance sheets of the corporates and the lenders.
This would mean, basically, that a National ARC be formed to buy a significant part of the stressed assets using budgetary resources. The price of the assets can be determined by an independent panel, to be accepted by all parties. The role of the government should be to facilitate, and purchase, the stressed assets at an independently determined price.
While the above suggested measure may initially appear to be drastic, at least going by the theory of incentives, there is actually no practical alternative without the major involvement of the government. Had there been one, the same would have already been adopted by the private parties.
In terms of the benefits from adopting this approach, the corporate investments will get an immediate kick-off leading to demand and job creation. This, in itself should be a huge kicker for the economy. 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. The details of the solution can be further worked out through time-bound consultations by the Government with the RBI, lenders, borrowers, and other relevant stakeholders and independent experts.
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.
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