Why India needs a bad debt agency

Bad debts in state banks are rising but handling them without crimping economic growth will be tricky. Is a bad debt agency the answer?

For an economy that is currently growing at an electric pace, India has a dark worry gnawing at its heart: mounting bad debts.

From a macro level all seems fairly good. The country reported GDP growth of 7.3% in 2015, a very rosy level when compared to most of the rest of Asia.

Yet all is not well in the world’s largest democracy. Economists fear its economic growth is overstated, while problem loans are building up, particularly among the state-owned lenders that control about three-quarters of the country’s bank assets.

The Indian Express reported that 29 state-owned Indian banks wrote off INR1.14 trillion ($16.7 billion) in bad debts in the last three full fiscal years to March-end 2015, according to the Reserve Bank of India.

Quoting the Indian central bank, the report said total bad debts stood at INR525.4 billion by the end of fiscal year 2014/2015, with State Bank of India alone writing off INR213.1 billion during the 12-month period.

All told, 11.1% of the Indian bank sector's gross assets were stressed as of March 2015, according to the RBI. 

The volume of stressed assets is partly rising because state banks, including SBI, lent to a series of unprofitable but politically sensitive infrastructure and power projects. India’s politicians and its judicial system are also reluctant to shutter businesses that may employ thousands, while the country’s bankruptcy laws are disparate and weak. Forcing companies into insolvency is extremely difficult.

India's growing debt worries led RBI governor Raghuram Rajan to warn on February 11 that the country's lenders needed to classify many of the loans they could not sort out for “deeper surgery”. He wants the banks to sort out their bad debt by March 2017.

As part of this effort the RBI has directed banks to raise the current 5% provisioning required for any restructured loan – where the borrower has restructured the payment terms – by 2.5% every quarter from April 1 to a maximum 15% by March 2017. That is the same level Indian banks currently have to provision against official non-performing assets.

That follows the decision last year by several state banks to reclassify some borrowers as NPAs, due to pressure from the central bank. As a result, five of the eight state banks that had announced their October-December quarterly results by February made a loss, according to The Hindu newspaper.

India’s nationalistic government won’t countenance merging state banks or selling them to the private sector. Yet simply bailing out what looks likely to become a mounting bad debt problem would likely impact the government’s budget and deficit expectations, potentially crimping economic growth for the year.

So New Delhi should look to another option to conduct the surgery Rajan believes necessary: a bad debt agency.

Bad debt specialist

Many countries have found it necessary to establish bad debt companies.

China in 1999 set up four so-called asset management companies – Huarong, China Great Wall, Cinda and China Orient – to siphon off the dud loans of its four largest lenders.

South Korea, similarly, formed the Korea Asset Management Company after the 1998 Asian financial crisis, to deal with the country’s cornucopia of chaebol-linked bad debts.

Essentially, bad debt companies purchase the loans that borrowers are unwilling or unable to repay at sharp discounts. They then chase these borrowers and try to convince them to offer something in return. It’s laborious work and it can take years to get outstanding debtors to settle defaulted loans, especially if they are large and well connected.

However, the good news is that settling these loans is the sole focus of a bad debt agency, unlike banks, which are often conflicted as the clients might well conduct business across multiple product lines.

Additionally, bad debt agencies typically enjoy explicit central government support in their actions, to ensure they have the clout to be effective.

India particularly needs an effective debt arbiter, given the weakness of its outstanding bankruptcy laws. Yet without the ability to threaten with the full force of the law, debtor companies face relatively few consequences by delaying debt payments.

The government understands the problem; finance minister Arun Jaitley tried passing a modern bankruptcy law in late 2015, which among other things envisaged a fast-track regime for resolving corporate insolvency of less than 90 days and a maximum resolution period of 270 days. But under opposition pressure, he sent the draft law for parliamentary review in December. The results review panel is meant to discuss its findings this month.

Given the delay, the government might well benefit from ensuring the proposed new law incorporates a bad debt company as well.

Such a company would buy particularly troubled NPAs from the banks at a discount.

Ideally it would be allocated explicit powers to force a settlement on negligent debtors, with the power to force organisations that do not cooperate into insolvency. 

The government would need to initially capitalise such an agency to buy bad debts but once it established its credentials it could raise capital in its own name via equity or vanilla debt issues, or potentially by securitising the bad debt portfolios it accumulates.

After all, China’s asset management companies have shown that is entirely feasible.  

None of this will entirely solve the bad lending habits of many Indian state banks. But short of a political change of heart over restructuring state banks, a bad debt agency may help India to better manage its mounting bad debt conundrum.   

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