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India needs multiple bad banks to clean bank balance sheets; get credit growth back
Dec 19, 2020

Confederation of Indian Industry (CII) has urged the government to consider creation of multiple bad banks to address the adverse impact of non-performing assets accumulated by public sector banks in the recent past, that got further accentuated during the pandemic. CII, in its recently submitted pre-budget memorandum to the government has recommended that the government consider enabling Foreign Portfolio Investors (FPIs) and Alternative Investment Funds (AIFs) to purchase NPAs.

Explaining the rationale, Mr Uday Kotak, President CII, said; “In the aftermath of Covid it is important to find a resolution mechanism through a market determined price discovery. With huge liquidity both globally and domestically multiple bad banks, can address this issue in a transparent manner and get the credit cycle back in action.”

A robust market-based mechanism will encourage PSBs to sell their bad loans, without fear of questions being raised later. With cleaner balance sheets, PSBs should be able to raise capital from the market, obviating the need for re-capitalization by government, a bill which the government can ill afford to foot at this point of time.

The government has put in INR 80,000 crores in bank re-capitalization in FY 18, INR 108 crores in FY 19 and INR 70,000 crores in FY 20. In September this year Parliament approved another INR 20,000 crores of capital infusion into PSBs. 

Hitherto the NPAs have largely been sold to Asset Reconstruction Companies (ARCs). Due to the limited capital that ARCs have, many sales are made not on cash basis but on Security Receipts (SR). SR is an instrument wherein the payment is made only upon recovery which means that the sale price is not a ‘true sale’. Based on recent RBI data on outstanding SRs, industry estimates that the net recovery rate of ARCs is low and may be in the range of only around 10-12%. The outstanding SRs is Rs 1.46 lakh crores. This represents the “non-cash” consideration received by banks against sale of loans.

The low recovery rates and the sale on the basis of SRs is not a very attractive proposition for banks. The best way to achieve true price discovery and better realizations is to open the buy side and enable a clear path for capital to flow for purchase of NPA.

The buy side could be opened by allowing Foreign Portfolio Investors (FPIs) and Alternative Investment Funds (AIFs) to purchase NPAs.

RBI has already contemplated this in a consultative paper wherein, it has proposed that regulated entities may be permitted to purchase NPAs. CII has suggested that

SEBI regulated AIFs may be permitted to purchase NPAs. This will be in sync with the RBI consultative paper of regulated purchaser.

Appropriate regulations may be framed by SEBI to safeguard the interest of all stakeholders.

Taxation of gains of such recovery, may be made investor friendly to attract global investors into such AIFs and to ensure price maximization for selling banks.

RBI in its latest Financial Stability Report has estimated that the gross NPAs of Scheduled Commercial Banks may increase from 8.5 per cent in March 2020 to 12.5 per cent by March 2021 under the baseline scenario and the ratio may escalate to 14.7 per cent under a very severely stressed scenario.

Another recent RBI working paper, Asset Quality and Credit Channel of Monetary Policy Transmission in India, points out that the deterioration in asset quality is partly responsible for slow credit offtake since 2013. Credit growth of public and private sector banks was 15% and 17.7%, respectively in September 2013. Credit growth of private sector banks accelerated, with growth remaining more than 20 % between December 2017 and March 2019. For PSBs the growth remained below 10% post December 2016. Credit growth for all scheduled commercial banks was only 5.8% in November 2020.

As the economy recovers, credit demand from industry will expand. Banks need to gear up to meet this demand. Market mechanism based multiple bad banks can help clean up bank’s balance sheets, encouraging them to lend.

19 December 2020

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