The total stress in the Indian banking system is about ₹14 lakh crore. In other words, this is the amount for which loans have been given to industry and for which there is now no certainty of repayment. The figure is set to increase with the banking regulator recently raising a red flag over the indebtedness of the telecom sector and asking banks to increase standard asset provisioning. This means that even if the account is not a non-performing asset (NPA), banks have to set aside higher capital. In fact, the Reserve Bank of India (RBI) has asked banks to identify stressed sectors and to make higher provisions to prepare for bad days ahead.
Bad loans in the Indian banking system have almost doubled in the past year. According to Reserve Bank of India data, gross NPA, as a percentage of gross advances, went up to 9.1% in September 2016 from 5.1% in September 2015. In the same period, stressed assets (which is gross NPA plus standard restructured advances and write-offs) moved up from 11.3% to 12.3%. Some estimates suggested it had doubled since 2013. Public sector banks share a disproportionate burden of this stress. Stressed assets in some public sector banks have approached or even exceeded 20%.
A PARA solution
Amid the sharp rise in NPA, talks of setting up a ‘bad’ bank have been gaining momentum. The government and the RBI are drawing up strategies on how to operationlise such a scheme. The economic survey of 2016-17 pointed out the twin balance sheet problem — stressed companies on one hand and NPA-laden banks on the other — and advocated a centralised Public Sector Asset Rehabilitation Agency (PARA) be established to deal with the bad loans problem.
“Private Asset Reconstruction Companies (ARCs) haven’t proved any more successful than banks in resolving bad debts,” the economic survey had said while proposing the ‘bad’ bank. “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,” it added.
One challenge private sector ARCs face is that of capital. None of the entities till now has been allowed to tap the capital market for raising funds. Kotak Mahindra Bank, which recently took its board’s approval to raise ₹5,300 crore equity said the bank also wanted to capitalise on opportunities in acquisition and resolution of stressed assets in the banking sector including participation in a ‘bad’ bank. Kotak Mahindra Prime and Kotak Mahindra Investments, companies in the Kotak Mahindra Group are sponsors of the asset reconstruction company Phoenix and together own 49% stake in it.
“Total estimated stress in Indian banking is about ₹14 lakh crore,” Uday Kotak, VC and MD, Kotak Mahindra Bank said. “Out of ₹14 lakh crore, about ₹4 lakh is the further pain which the banking system has to take.” That is, another ₹4 lakh crore could move from being tagged as stressed assets to actual NPAs. To put things in perspective, ₹4 lakh crore is 50% of the total capital of Indian banking today, he said.
“The ARCs are badly capitalised. We see significant opportunity for Kotak in this,” Mr. Kotak said adding the country would need 2-3 well-capitalised ‘bad’ banks.
Some central bank as well as government officials also admitted capital was the biggest challenge in setting up a ‘bad’ bank. “At least ₹25,000 to ₹30,000 crore of capital will be required to set up a bad bank in the initial stages. Where will the money come from?” asked a senior central bank official.
Two models
RBI deputy governor Viral Acharya recently suggested two models to solve the problem of stressed assets. The first, Private Asset Management Company (PAMC), is said to be suitable for sectors where the stress is such that assets are likely to have economic value in the short run, with moderate levels of debt forgiveness. Some of the sectors which this model could address metals are telecom and textiles.
In this model, each resolution plan would get vetted and rated by at least two credit rating agencies to assess the financial health and in terms of timeline, the banking sector may be asked to resolve and restructure, say, its 50 largest stressed exposures in these sectors, by December 31, 2017, the deputy governor had proposed.
The second model is the National Asset Management Company (NAMC), which would be necessary for sectors where the problem is not just one of excess capacity but possibly also of economically unviable assets in the short- to medium-term. Mr. Acharya cited the example of the power sector, where projects have been created to deliver aggregate capacity that is beyond the estimated peak utilisation any time soon.
“Unlike the first model (PAMC) where asset recovery is likely to be relatively quick, these assets may require a long time to start generating cash flows,” Mr. Acharya said. He, however, declined to call these entities as ‘bad’ banks.
“Are these supposed to be ‘bad banks’? The answer is ‘No’. While I have previously used the phrase for such ideas, over time I have come to dislike the title. A ‘bad bank’ conveys the impression that this entity is to operate as a bank but has bad assets to start with. In fact, the idea is not to operate these entities as banks at all,” he said in a speech.
He said it would be better to limit the objective of these asset management companies to orderly resolution of stressed assets with graceful exit thereafter.
The Korean experience
The Korea Asset Management Corporation (KAMCO) played a major role in resolving stress in its banking system which was at the heart of the financial crisis that the country faced in 1997-98. The recovery was characterised by a rapid and drastic reduction in the level of bad loans in the financial system.
A study by the International Monetary Fund said KAMCO first purchased distressed assets from banks and other financial institutions, which allowed lending to resume at a time of scarce liquidity. “This objective was complemented by increased supervision to ensure that banks were operating on sound commercial principles.”
The study noted KAMCO’s resolution of bad loans contributed to the good progress made in Korea in recovering public funds injected by the government for financial sector restructuring. “In addition, KAMCO disposed of many of these distressed assets through a number of innovative methods, including by issuing asset-backed securities, which launched an important new market in Korea,” it said.
The Korean government announced a programme of NPA acquisition as a mechanism to deliver official support for bank restructuring in November ’97. A key component of the programme was the establishment of a reorganised and expanded KAMCO, and the creation of the NPA Fund.
