BAD BANK

BAD BANK

Govt considers ‘bad bank’ proposal despite doubts.

FinMin officials say an announcement could be made in the Budget

Arup Roychoudhury & Dilasha Seth

BS February 19, 2016

The Centre is likely to set up a “bad bank” to take over the non-performing assets (NPAs) of the country’s financial institutions, and is examining a policy proposal paper on the matter.

As such, the setting up of an asset reconstruction company backed by the sovereign is a long-drawn process and these are still early days. Even then, senior government sources say Finance Minister Arun Jaitley might make an announcement in the upcoming Union Budget as part of his medium-term plans for the financial sector. There have been inter-ministerial discussions on the matter.

Earlier in February, Reserve Bank of India (RBI) Governor Rajan had said there was “no need” to set up a separate “bad bank” to deal with stressed assets of public sector (PSU) banks. “PSU banks themselves have the backing of the government, so there is no need to create a new entity that has the backing of the government. The issue is now to clean it up,” he had said at an event in New Delhi.

Rajan had also said the pricing of assets of a government-owned bad bank could get entangled with the Comptroller and Auditor General or the Central Vigilance Commissioner.

“The government is examining the proposal of setting up a ‘bad bank’, which will take over NPAs of public sector lenders and help them clean up their books. Deliberations with stakeholders are in the initial stages,” said an official.

The third quarter of financial year 2016 saw a sharp rise in banks’ NPAs because of stress in sectors like steel, power and infrastructure.

“The (RBI) governor has made valid points, which will be taken on board. However, there is no rule that says if the regulator is opposed to something it should not or cannot be done. A decision will be taken considering all views,” the official added.

The asset reconstruction company would not be RBI’s problem as it would just take over toxic assets of banks, said another official. However, experts say a bad bank alone will not be a solution, it will have to be ensured that banks do not fall back and come up with more toxic assets.

Sources said the idea was being drawn from various countries that had set up such banks, the latest being the Troubled Assets Relief Program (TARP) by the US Treasury after the collapse of Lehman Brothers in 2008.

However, the aim will be to ensure that the exchequer does not take the entire financial hit and that banks themselves be asked to pick up the burden once they have cleaned up their books. Under the Indradhanush scheme, while the government’s promise of recapitalising PSU banks over a three-year period seems to be on track, it seems inadequate considering the scale of stress. Of the Rs 25,000 crore meant for 2015-16, the government has pumped in about Rs 20,000 crore in 13 PSU banks so far. The government will infuse another Rs 5,000 crore in the current financial year to strengthen bank balance sheets. PSU banks will get Rs 25,000 crore in the next financial year, followed by Rs 10,000 crore each in 2017-18 and 2018-19.

For the December quarter, almost all state-owned lenders reported lower profits or slumped to losses on the back of higher provisioning for NPAs. State Bank of India Chairman Arundhati Bhattacharya has warned that the level of NPAs might rise in the March quarter, even as Jaitley promised further steps to deal with the situation.

THE PROPOSALS

Centre studying proposal paper on govt-backed asset reconstruction company / ‘Bad bank’ to take over NPAs of PSU banks and help them clean balance sheets / Banks expected to bear the burden of such a move / Sources say deliberations at an early stage.

COMPILED BY ME

MY LETTER TO BUSINESS STANDARD ON BAD BANK

BAD BANK

Dear Sir,

This refers to the news item titled: ”Govt considers ‘bad bank’ proposal despite doubts” (BS 19^TH FEB 2016). The idea seems worth trying. It is understood that basically, the concept is that a Bad Bank is set up to buy the bad loans of a bank with significant non-performing assets at market price. By transferring bad assets of an institution to the bad bank, the banks attempt to clear their balance sheets of toxic assets but would be forced to take write downs. However, shareholders and bondholders would stand to lose money from this solution but not depositors.

Banking world history is full of several instances of Bad Banks being opened. One such famous oft quoted example is the Grant Street National Bank, which was created in 1988 to house the bad assets of Mellon Bank New York. Further the US sub-prime mortgage collapse of 2008 had revived interest in the bad bank solution, as managers at some of the world’s largest banking institutions had then contemplated segregating their non-performing assets into bad banks.

It may be recalled that sometime in 2009 a report by McKinsey & Company had identified four basic models for bad banks: (a) In an on-balance-sheet guarantee, the bank uses some mechanism (typically a government guarantee) to protect part of its portfolio against losses. While simple to implement, this situation is difficult for investors to assess. (b) In an internal restructuring, the bank creates a separate unit to hold the bad assets. This solution is more transparent, but doesn’t isolate the bank from risk. (c) In a Special Purpose Entity (SPE), the bank transfers its bad assets to another organization, typically government backed. Such a solution would require substantial government participation. In the Indian context RBI and Fin Min will have to see which model best suits their needs.

Experts are of the view that the first year of the bad bank determines its success. The challenge is the large number of non-performing loans in a wide variety of sectors with many geographical locations, several types of industries, sizes and types of problems. If the bad bank does not quickly get control of the loans, a lot of value will be lost and the capital requirements of the bad bank will change drastically.

To be successful, a well-defined process on how to handle the different loans has to be established. This process has to be followed and managed with force and speed or else the bad bank will easily end up in chaos. Let us hope RBI takes a quick decision on this vital issue. Further RBI Governor Rajan has opined that the pricing of assets of a government owned bad bank would get entangled with the Comptroller and Auditor General or the Central Vigilance Commissioner. Hence the move of opening a Bad Bank will have to be carefully orchestrated to avoid political undertones and undercurrents. Let see how and in which way the cookie crumbles!

J S BROCA New Delhi 19^th Feb 2016