The government is reportedly considering an asset management entity to facilitate transfer of non-performing assets (NPAs) from public sector banks (PSBs) to asset reconstruction companies (ARCs), without creating a separate bad bank that will house the bad loans.
This is not a great idea. The sensible thing to do is for the State-owned banks to come together and jointly set up a bad bank, to which the bad loans on the banks’ books can be offloaded and resolved at leisure. Why set up a bad bank? Credit offtake is quite low, in spite of low rates and plenty of liquidity. Paucity of demand for credit is the primary constraint.
However, even when demand picks up, banks saddled with bad loans will not find it easy to lend. For credit to flow again, banks must be relieved of their bad loans, which could grow to over 15% of total loans by next March, according to RBI.
Why not simply sell the bad loans to the many ARCs that already exist? Why create a new bad bank? Because of the political economy of State-owned banks. Managers worry that the discount to the nominal value of the original loan at which its NPA avatar is sold to an ARC could invite charges of causing loss to the exchequer and enriching the ARC. That is why an ARC that is jointly owned by the PSBs is needed.
It can offer the patient capital needed to resolve bad loans optimally, and the gains made over the cost of acquiring the bad loans would accrue to the banks themselves. Unless the resolution process in the new bad bank is crookedly designed to sell off assets cheap, it would recoup a fair bit of the value lost by the banks when they transfer their assets to the bad bank in the first place, and these gains would be passed on to the PSBs that own the bad bank.
To insulate managers further from arbitrary criminalisation of NPA sales, third parties, say, a firm of chartered accountants, could be asked to fix the minimum value of the assets to be transferred. Such double layers of reassurance would be afforded only by a new bad bank, not an asset management entity.
This piece appeared as an editorial opinion in the print edition of The Economic Times.