One of the leading issue in Indian economy is the unresolvable nature of the stressed asset problem in the banking sector. Both NPAs and Stressed Assets are rising and has reached the post-reform highs. India’s bad debt is one of the worst among the emerging peers. Besides the worsening stressed asset scenario, the failure of existing arrangements created to tackle bad debts is also a matter of concern. In this regard, the Economic Survey 2017 makes a restatement of the Twin Balance Sheet (TBS) problem it has invented last year while assessing the NPA scenario. Twin Balance Sheet (TBS) problem indicate the weakened financial positions of the Public-Sector Banks (PSBs) and some large corporate houses. The Survey (2017) while examining the failure of existing initiatives like (ARCs, JLF, SDR, S4A etc.), argues for the creation of a dedicated government run asset reconstruction agency which is named as Public Sector Asset Rehabilitation Agency (PARA). The PARA is proposed as a government owned and managed agency that deals with bad assets of PSBs. Given that bulk of the bad assets are with PSBs, it is suitable for the government to make such a non-market/centralized entity to deal with the financial health of its own institutions. Such a step will help the economy to tide over the bad asset problem which is hindering Indian’s economic growth. Following are the main arguments cited for the creation of PARA.
1. The current bad debt problem is more serious
Over the last one decade; and especially in the last few years, the bad asset problem in India’s financial system is aggravating. The level of Gross Non- Performing Assets (GNPAs) has increased to 9.1% in September 2016 from 7.8% in March 2016. Similarly, the stressed assets (NPAs + Restructured loans + written off loans) increased to 12.3% from 11.5% in the same period. The trend for future also indicates rising NPAs.
Why an urgent need for solving the NPA problem?
The Asset quality worsening trend is here for several years. But the current situation necessitates urgent action because of the following reasons.
- Firstly, the NPAs are at the higher level after the crisis and reform years of early 1990s.
- Secondly, India’s current NPA ratio is higher compared to most of other EMEs (except Russia).
- Thirdly, the NPA problem is severe for PSBs.
The Economic Survey uses the term Twin Balance Sheet problem to indicate the stressed situation of banks and corporate at the same time. Here, the Corporate are in a financial trouble as their investment is not giving profit because of difficult economic environment. In the same way, the banks are facing stressed assets including high NPAs because of non-repayment of debt taken by the corporate. In effect, the balance sheets of banks and corporate are simultaneously under trouble and are highly related. The TBS problem emerged only by 2010 while the systemic stress in the banking system is gradually growing since then.
2. High level of NPAs for Public Sector Banks (PSBs)
The Asset (mainly loans) quality deterioration is particularly strong for PSBs. According to RBI’s Financial Stability Report (December 2016), more than four-fifths of the non-performing assets were in the PSBs. The NPA ratio for them has reached up to 12 percent. As per the Financial Stability Report, the PSBs’ GNPA ratio may increase to 12.5 per cent in March 2017 and then to 12.9 per cent in March 2018. Thirteen of the PSBs who holds 40 per cent of total loans are severely stressed. Over 20 per cent of their outstanding loans are classified as restructured or NPAs. The return on assets is negative, implying that they are accumulating losses.
3.The existing arrangements have failed:
There are several market oriented mechanisms created by the RBI along with other regulators and the Government to tackle the bad debt problem. The ARCs, SDR, S4A are some of them. But most of them have failed or are underperforming.
The SARFAESI Act encouraged creation of Asset Reconstruction Companies and there are 19 ARCs in India as on February 2017; most of them private. But the contribution of ARCs in asset reconstruction is negligible. In 2014, the RBI asked ARCs to pay a greater proportion of the purchase price up-front in cash. Since then, asset reconstruction activities came down. They have bought up only about 5 percent of total NPAs at book value over 2014-15 and 2015-16. ARCs have found it difficult to recover money from the debtors. As a result, the ARCs were able to offer only low prices to banks. This low pricing of bad assets is discouraging for banks to sell their assets to ARCs.
In the context of slow asset securitization oriented resolution, the RBI has introduced two bank-based mechanisms. First was the Strategic Debt Restructuring (SDR) scheme launched in 2015. Here, creditors or banks could take over firms that were unable to pay and sell them to new owners later. In 2016, a similar programme called Sustainable Structuring of Stressed Assets (S4A) was announced. Under this scheme, creditors could provide firms with debt reductions up to 50 percent in order to restore their financial viability.
But the progress of these two schemes were also quite limited. Only two cases have been concluded under SDR as of end-December 2016. In the case of S4A, only one small case has been resolved till January 2017.
Debt write downs have discouraged banks to engage with S4A. Here, they must make large debt reductions to restore viability in many cases. But public sector bankers are reluctant to grant write-downs because of no return from it. Debt write-downs in the case of the large debtors may deplete banks’ capital. At the same time, write-downs can attract the attention of investigative agencies.
Several other attempts like Joint Lenders Forum (JLF) have yielded only limited returns in tackling bad assets. In the case of JLF, decisions can be taken by 75 percent of creditors by value and 60 percent by number. But reaching consensus under JLF proved difficult, as different banks have different degrees of credit exposure, capital cushions, and incentives. Acute coordination failures when the bad debt involve large amount has been reported.
4. Stressed asset of large companies are difficult to resolve.
The NPA problem is not just the problem of banks. It is a byproduct of the poor performance of the loan takers which are basically large corporate. Though there are cases of mismanagement of borrowed money by the corporate from banks, bulk of the bad debt problem has been caused by unexpected changes in the economic environment like delay in project implementation, exchange rates, growth rate assumptions going wrong etc.
The stressed asset profile of PSBs indicate that they are concentrated in few big borrowers. According to the Economic Survey 2017, as on September 2016, about 33 of the top 100 stressed debtors would need debt reductions of less than 50 percent, 10 would need reductions of 51-75 percent, and no less than 57 would need reductions of 75 percent or more. A mere 50 companies account for 71 percent of the debt owed by debtors. According to the RBI, on average, these 50 companies owe Rs 20,000 crores in debt, with 10 companies owing more than Rs 40,000 crores each.
Many of these large companies are having big debt needs debt write-downs to stay in business so that they can repay debt in future. Cash flows are deteriorating and debt reductions of more than 50 percent is needed to restore viability.
The only alternative here would be to convert debt to equity, takeover of the companies, and then sell them at a loss. For this, the RBI launched SDR and S4A schemes; but both of them failed to address the issue.
5. Delay is costly: The biggest problem out of stressed assets is delay. If the solution of the problem is delayed, bad debt keeps rising and it raises the costs for the government to finance the PSBs. Similarly, stressed banks continue to avoid giving loans and this will adversely affect investment in the economy.
Hence there is the need for PARA
So far, the Private Asset Reconstruction Companies (ARCs) have failed to solve bad asset problem. At the same time, in international experience shows that a professionally run central agency with government backing can overcome the above difficulties.
The current serious stressed asset situation and the inability of the existing arrangements necessitate an immediate resolution of the problem. As the Economic Survey argues “it has now been eight years since the twin balance sheet problem first materialised, and still no resolution is in sight. And because the financial position of the stressed debtors is deteriorating, the ultimate cost to the government and society is rising – not just financially, but also in terms of foregone economic growth and the risks to future growth.”
The Survey hence demands a non-market and centralized approach like the Public Setor Asset Rehabilitation Agency (PARA) to solve the problem.