The success of India’s latest gambit to clean up the banking system’s toxic assets through a ‘bad bank’ will hinge on several factors, and global evidence shows such initiatives worked better when accompanied by the recapitalisation of banks, the Asian Development Bank (ADB) said.
The bank has flagged that India’s resolution process under the Insolvency and Bankruptcy Code (IBC) remained ‘skewed’ and raised concerns about rising non-performing loans (NPLs) and low uptake of bank credit deterring private investments, in its Asian Development Outlook update last week.
While the IBC had led to a paradigm shift in the resolution process, quicker and more efficient resolutions are important for improving resource allocation in the economy, ADB’s Rana Hasan and Shalini Mittal said in response to queries from The Hindu . Mr. Hasan is the Bank’s regional economic adviser for South Asia and Ms. Mittal is an associate economic analyst.
The government has already taken measures to speed up resolution of bad loans through the National Asset Reconstruction Company Limited (NARCL), which will strive to resolve the twin balance sheet problem of the banks by easing the stress on banks’ balance sheets and enabling them to direct resources to more productive assets, they noted.
While the NARCL could ensure that NPLs are resolved in a time-bound, efficient manner under expert guidance, the ADB economists cited global experience with such entities and said several factors would be critical in determining its success.
“Many countries in the past have established such companies to resolve NPLs. KAMCO, established in Korea in 1997, played a key role in acquiring and resolving financial institutions’ bad loans and corporate restructurings. Similarly, Danaharta in Malaysia had a lifetime loan recovery rate of 58%,” they pointed out.
“At the same time, recapitalisation of banks will help strengthen banks’ balance sheet, improve capital adequacy ratio and encourage banks to lend more, thereby improving the credit flow in the system. Evidence from 135 major banks across 15 European Union nations and Switzerland showed that segregation of impaired assets (into a bad bank) worked when done along with recapitalisation of the banks,” Mr. Rana and Ms. Mittal emphasised.
The latest Financial Stability report from the Reserve Bank of India (RBI) also referred to other key factors for the NARCL’s success, they said. These include fair pricing of loans, segregation of risk from selling banks, roping in capital from the private sector along with independent and professional management of the new entity. Minimising moral hazard and adequate capitalisation of the banks, after the sale of assets to invigorate fresh lending, would also be critical.
“The central bank is likely to continue its accommodative stance and support the economy through liquidity measures and reform in the financial industry. However, improving credit flow to support domestic investment requires making the resolution process for stressed assets more efficient,” the ADB had emphasised. “Setting aside two large recoveries, only 31% of defaulted assets have been recovered,” it added.
The bad loan ratio in the banking system is expected to rise to 9.8% by March 2022, as per the RBI, after having climbed from 6.8% last December to 7.5% in March 2021. New project announcements in the first quarter of 2021-22 amounted to just 44.3% of pre-pandemic levels with only 0.3% of outstanding projects completed, the ADB update pointed out.