Can We Bank On The BUDGET?

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Addressing industry bodies in December, Finance Minister Nirmala Sitharaman promised vibrancy in the Union Budget, a key to economic revival, and keeping the momentum in public spending in infrastructure going. She also said India is set to be an engine of global growth.

The onus of reigniting the growth engine in Asia’s third-largest economy is on the banking system. There have been many unkept promises made in the previous budgets, including Yashwant Sinha’s February 29, 2000 Union Budget that spoke of reducing the government shareholding in nationalised banks to 33 per cent without changing the public sector character of such banks.

What exactly is the industry looking for this time?

The expectations are veering towards the setting up of a bad bank; the creation of a development financial institution (DFI) to take the load off banks in infrastructure financing; and the privatisation of some of the public sector banks.

Recently, while advising banks and non-banks to adopt the right compliance culture and identify risks early, Reserve Bank of India (RBI) Governor Shaktikanta Das said India’s central bank could consider the idea of a “bad bank” to tackle the rising bad loans. By RBI’s estimate, the non-performing assets (NPAs) of the banking sector could almost double to 14.8 per cent of advances by September 2021 from 7.5 per cent in September 2020.

Public sector banks, the most vulnerable of the lot, might see their NPAs rising to 17.6 per cent from 9.7 per cent, in severe stress scenario. Against this backdrop, Das’s comment (“We are open to look at any proposal to set up a bad bank”) has once again sparked off a debate on the creation of such a bank.

The industry has been toying with the idea for quite some time. In May 2020, the Indian Banks’ Association (IBA) had submitted its proposal for setting up a bad bank to the finance ministry and the RBI. Even before that, in January 2017, the Economic Survey suggested setting up a public sector asset rehabilitation agency, while former RBI deputy governor Viral Acharya suggested two bodies for cleaning up the bad loan problems of the ailing public sector bank – a private asset management company and a national assets management company.

If the government sees merit in the proposal, we will see the creation of an asset reconstruction company for taking the bad loans off the banks’ balance sheets in lieu of the so-called security receipts (SRs), which will be converted into cash after the recovery. The IBA favours setting up of an alternative investment fund to help trading in these SRs in the secondary market and, for managing the bad loans, an asset management company run by private and public bodies.

Most experts, who have been pitching for it, are referring to the Danaharta experiment in Malaysia – a bad bank set up after the Asian financial crisis. While the government funded the venture, professionals ran the show even as laws were changed to ensure its success. Yes, Danaharta is a great success story. So is the $426.4 billion Troubled Asset Relief Program of the US Treasury, launched after the global financial crisis to buy toxic assets and equity from the financial institutions and strengthen the system. But, will such an experiment work in India? Or, will it simply push the muck under the carpet?

Even though the Budget may flag off the creation of a bad bank, a better way of cleaning up the mess will be allowing each bank to create a bad bank within itself, curving out bad loans, with a central mechanism in place for coordination and for speeding up the recovery process. At the same time, the loopholes in the insolvency law need to be plugged. Instead of one bad bank for the industry, let a dozen bad banks bloom.

There have been talks of the government planning to set up a DFI for financing infrastructure development. In a recent interview to news agency PTI, Financial Services Secretary Debasish Panda emphasised the need for a DFI as infrastructure financing requires patient capital and banks are not equipped to lend to long-term projects. According to Panda, the government is in the process of finalising details such as shareholding of the entity and deciding on whether it will be formed through a statute.

Theoretically, it’s a perfect solution. A DFI can play the role of a catalyst and rush in where others fear to tread because of the risks involved. One of the key reasons for the pile-up of bank bad loans, many say, is the abolition of the DFIs in the late 1990s. India embraced universal banking with open arms but our banks, used to lending working capital, have never felt comfortable in project financing. To queer the pitch further, the bond market has not developed well enough to support infrastructure financing. So, we need the DFIs. Right?

It’s a winner only if we know where the fund will come from. The DFIs had to die after their source of cheap money dried up, forcing them to run huge asset-liability mismatches. Can the government support such an institution with cheap long-term money?

Incidentally, the previous two attempts to set up exclusive infrastructure financing entities have failed miserably as the management of such bodies was never held accountable. The Infrastructure Leasing and Financial Services Ltd boss ran it for decades like a promoter and left like a professional after it crumbled under mismanagement. Infrastructure Development Finance Company – a child of the July 1996 Budget – had to be converted into a bank as it could not survive in its original avatar.

Yet another expectation from the February 1 Budget is privatisation of weak government-owned banks or lowering the government shareholding in such banks, something on the lines of what Sinha had suggested in 2000. In a recent media interview, Panda said the soon-to-be-unveiled privatisation policy for public sector enterprises would lay the road map for mergers and amalgamation among state-owned banks.

This is welcome. All have been waiting for this. With Life Insurance Corporation of India preparing for its stock market debut, one can assume that there won’t be a mockery of bank privatisation ala IDBI Bank style. If indeed the government bites the bullet, it will be for real. The question is: Will it?

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