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Government plans big push to rid banks of rotten assets

These 3 strategies are - asset swaps, a bank-by-bank cleanup and a bad bank. The matter is likely to be discussed later this month, a senior official said.

Last Updated: Oct 11, 2016, 07.02 AM IST
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The NPAs of scheduled commercial banks rose to 8.7 per cent of total credit by the end of June compared with 4.6 per cent in March 2015 and 7.8 per cent in March 2016.
The NPAs of scheduled commercial banks rose to 8.7 per cent of total credit by the end of June compared with 4.6 per cent in March 2015 and 7.8 per cent in March 2016.
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NEW DELHI: The government wants to put together a plan to purge the banking system of bad loans, seen as the single biggest hurdle in the way of an investment revival that’s badly needed to push growth.

On the table are said to be three possible strategies — asset swaps, a bank-by-bank cleanup and a bad bank. The matter is likely to be discussed later this month, a senior government official told ET.

“There is unanimity at the highest level that economic growth cannot just happen on the back of public investment. We need to revive capital flow to private players and this can happen only when the government finds a solution to rising bad loans,” the senior official told ET on condition of anonymity. “Some big thinking is required… big discussion on this soon.”

There is need for urgent action
While India is the world’s fastest-growing major economy, the expansion is being supported by consumption and public spending with private investment lagging behind despite various reforms being undertaken by the Narendra Modi government.

The 0.7 per cent contraction in the index of industrial production in August feeds into this theme. The extent of rotten assets held by banks has been revealed by the Reserve Bank of India’s ongoing asset-quality review.

The gross nonperforming assets (NPAs) of scheduled commercial banks rose to 8.7 per cent of total credit by the end of June compared with 4.6 per cent in March 2015 and 7.8 per cent in March 2016.

According to RBI’s June Financial Stability Report, that last figure marked a 12-year high. RBI projects the gross NPA ratio at 8.5 per cent by March 2017. Rising bad loans have forced banks to set aside more and more funds to cover potential losses, badly denting earnings and preventing them from passing on rate cuts by RBI or stepping up lending.


Government plans big push to rid banks of rotten assets
Annual credit growth in September was pegged at 9.3 per cent. Abheek Barua, chief economist of HDFC Bank, agrees with the need for urgent action. Without that, key pieces of the Modi government’s growth initiative may flounder. “Given the state of the economy and credit, there is not too much option,” he said, adding the problem was becoming widespread.

“Credit to GDP ratio in most manufacturing economies, when they were growing, like Taiwan, Korea and Malaysia, grew by 130 per cent but in India it is at 56 per cent. Hence, credit is very critical for ‘Make in India’ to happen. We can’t do it at the back of massive public spending only and will have to ensure that credit to private sector starts flowing.”

Asset swap
Some form of asset swap is already being practised, with debt being converted into equity in some companies. Another option is issuing bonds in lieu of such assets. In the case of real estate companies, debt could be swapped for land.


The bad bank option — an institution takes over all the bad debt — has been on the table for a while but former RBI governor Raghuram Rajan hadn’t been too keen on it. He believed this would work when private lenders were involved but in India’s case it’s mostly state-owned banks that are saddled with bad loans and the pricing of assets could be problematic.

But with a change of guard at the central bank, the proposal could find favour again. Barua agrees there is a need for some sort of government initiative to take bad loans off the books of state-run banks, in particular the non-State Bank group ones.

Since private asset reconstruction companies have not been able to deliver because of inadequate capital and valuation issues stalling asset sales, an entity with government capital to deal with the issue on a much wider scale is required, Barua said.

The third option — a bankby-bank cleanup — will ensure the government doesn’t spread itself too thin, said the official cited above.
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