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India sets up 'bad bank' to deal with massive unpaid loans

2021-09-27 00:00:00.0 海峡时报-亚洲原网页

BANGALORE - With unpaid corporate loans at a record high in India, the government has set up a "bad bank" to resolve such loans, paving the way for a major clean-up of the banking system.

Flush with 30.6 billion rupees (S$560 million), the new institution will take over bad loans from commercial banks amounting to two billion rupees, a quarter of the total stressed loans in the country.

Officially called the National Asset Reconstruction Company Ltd (NARCL), it will help the banks clear their balance sheet and focus on core business and lending activities.

A bad bank takes over the loans, usually below the book value, manages them and tries to recover the money over some years.

India's banking sector has been plagued with crises in recent years, from a multimillion-dollar fraud in the giant Punjab National Bank in 2018, corporate mismanagement in Yes Bank, and the unpaid loans fiasco at Lakshmi Vilas Bank, which led to its takeover by Singapore's DBS Bank last year.

Unpaid loans in public sector commercial banks have also been ballooning for at least a decade. The rise was further fuelled during the Covid-19 pandemic, which saw job losses and ailing businesses.

The amount now stands at over eight trillion rupees. At least 75 per cent of these are defaulted corporate loans.

In her Feb 1 budget speech, Finance Minister Nirmala Sitharaman mentioned the government's intention to set up asset management and reconstruction companies that together constitute a bad bank to provide financial stability to the banking sector.

Economist Vivek Kaul explained that bad banks have been set up in countries like the United States, United Kingdom, Japan and Malaysia to allow the banks to focus on their core business rather than on rescue and recovery.

Among the world's first bad banks was the one set up in the US in 1989 to sell the assets of around 750 bankrupt savings and loan institutions or thrifts that were worth nearly US$450 billion. It dissolved in 1995 after meeting its objectives.

The US bad bank was a private sector experiment with no capital from a government entity. India's bad bank, however, involves initial investment by the government.

Another difference lies in the types of bad loans. "Much of the Western experience of bad banks has been around toxic mortgages or home loans which had been defaulted on," said Mr Kaul.

In India, however, an overwhelming 75 per cent of bad loans are defaulted corporate loans, involving a consortium of banks that had given loans to corporations to finance large industrial or infrastructure projects.

"This increases the number of stakeholders. Hence, it makes the entire situation much more difficult to resolve," added Mr Kaul.

He said experiences in countries such as Mexico, Greece, South Korea, Argentina and Italy have shown that bad banks have rarely worked in settings where industrial, corporate and conglomerate-level bad loans dominate.