Introduction - The article focus upon the various strategies being adopted by different countries to tackle NPA problems and some suggestions for India.
- Indian banks have accumulated Rs.5.8 trillion in bad loans with the prospect of more to come. This can threaten an early economic recovery by stalling the flow of capital to critical sectors like infrastructure.
- It is this fear that has the government, the regulator and lenders scrambling to find a way to resolve bad loans.
- Solutions introduced so far such as the strategic debt restructuring (SDR) scheme have proved to be difficult to implement while court-driven resolution processes remain painfully slow.
- As India searches for a solution to its bad loan problem, it may be worth looking around the world to see how some other economies are tackling similar problems. Some of these models are being suggested as possible solutions for the Indian bad loan problem as well.
The Italian way
- The most recent example of a bad loan resolution plan of significant scale and size comes from Italy.
- There were two parts to the plan.
- The first part was a 5-6 billion euro bank stabilization fund dubbed ‘Atlas’. The fund was set up as a private alternative investment fund in which a number of Italian banks and financial institutions were investors.
- The fund is managed by an external agency and is set to invest in share issues by weak Italian banks while also buying non-performing loans from weak banks.
- The second and more interesting part of the Italian bad loan resolution plan is a proposal to allow banks to securitize bad loans with the government coming in and guaranteeing the most senior tranche of these loans.
- A senior tranche of a pool of loans is the one deemed least risky. By allowing this, the Italian government hoped that banks will be able to shed some of their bad loans.
China looks to securitization
- The idea of securitizing bad loans is something that has been used in China in the past as well and is being tried again.
- China is also experimenting with a debt-to-equity conversion plan, a tool similar to the SDR scheme being used in India. According to a May report from brokerage house CLSA, 15-19% of China’s bank loans are bad, necessitating a solution.
The bad bank experiments
- Apart from the newer resolution mechanisms being attempted, the classic bad bank approach has been tried in a number of economies ranging from Spain to Ireland.
- Both countries set up large state-backed asset management companies which bought stressed assets at low valuations from banks and later pushed out these assets to those specializing in stressed asset investing and recovery.
- Ireland had set up the National Asset Management Agency (NAMA) in 2009 for a period of 10 years. The agency had taken over almost 74 billion euro in bad loans from Irish banks in the aftermath of the crisis. It is expected to make a huge profit by the time of winding up.
- There have also been pure government-led solutions to bad loans which have been used by Japan and the US.
- Japan went through the exercise of cleaning up bank balance sheets in the late 1990s.
- The US, after the financial crisis, announced the much-debated Troubled Asset Relief Program (TARP) to purchase assets from financial institutions to strengthen the sector.
- TARP was set up after the collapse of Lehman Brothers in 2008 and initially allowed the US government to purchase up to $700 billion in troubled assets. By the end of 2014, TARP had been wound down with profits of nearly $15 billion.
What will work in India?
- A pure government-led solution seems unlikely in India given the constraints on government finances.
- However, the idea of a fund, which is sponsored together by the government and lenders, is an option that is being considered.
- Over the past month, government officials including finance minister have said that a government-sponsored fund is being considered. The Reserve Bank of India is cautious and has said that such a fund should not be majority-owned by banks.
- Meanwhile, the concept of securitization of bad loans is a tough one to implement in India. The securitization market in India has always been thin and there aren’t many sophisticated financial institutional investors who could provide liquidity to this market.
Question:In the past, different countries have adopted different mechanisms to tackle the problem of rising bad loans. Examine. Do you think, any of these solution will work for India. Comment.
- Different strategies adopted by different countries to tackle this problem.
- Analyse whether these mechanisms will work in Indian context.