Too much prudence with bad loans is bad–the economic times

Clipped from: https://economictimes.indiatimes.com/blogs/et-editorials/too-much-prudence-with-bad-loans-is-bad/ET Edit

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The reported proposal for banks to sell only bad loans that have been fully provided for to the bad bank proposed in the budget is, at one level, prudent, and, at another, too prudent. Any receipt against a loan that has been fully provided for will go straight to the bottomline. However, holding on to partially provided for bad loans will not serve the purpose of liberating the banks to start lending aggressively to fuel economic recovery.

Whatever kind of bad assets are transferred, two kinds of questions will remain, about the bad loan’s origination and pricing for transfer to the bad bank. Was there any mala-fide in the original sanctioning of the loan? This cannot be addressed by the choice of what types of assets are transferred to the bad bank. What is the fair price for the bad loan that the bad bank buys from the bank? The valuation problem can be addressed by letting a third party determine a value and having that reviewed by another set of eyes, as was successfully done in the first bad bank experiment in Pittsburg.

Mellon Bank of Pittsburgh set up Grant Street National Bank to buy its bad loans and resolve them. The unit was partially backed by junk bonds underwritten by an investment banking firm. The pricing of the loans for sale at a discount was done by accounting firm Arthur Andersen & Co, following which the price was reviewed by Kenneth Leventhal & Co. Similar arm’s-length pricing makes sense for India’s bad bank. An oversight committee will help protect the integrity of decisions taken by bankers. The bad bank must be run professionally and maintain an arm’s-length relationship with the bank. In tandem, the bankruptcy courts must do their job efficiently, and the market for corporate bonds must mature.

This piece appeared as an editorial opinion in the print edition of The Economic Times.

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