Can Asset Sales Resolve the Bad Debt Crisis?

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The Indian banking system is passing through tough times. Increasing bad loans, deteriorating asset quality and slow credit growth have marred the financials of the banks. Especially of public sector banks.

Data as of September 2015 portrays the dire state of the Indian banks. The bad loans, coupled with the restructured assets and the assets written off in total made up for 14.1% of the books of Indian banks. This means that for every Rs 100 of loan given, Rs 14.1 worth of loans were in dodgy territory. This figure for the public sector banks stands at 17.1%. It would have worsened after Reserve Bank of India’s (RBIs) directive to recognize and provide for the stressed assets.

Bad loans have partly eroded off the capital of public sector banks. Lack of funds and deteriorating asset quality is forcing the banks to go slow on lending. This is apparent from the slow growth as seen in the corporate lending. The banks are in need of funds.

Lately, they are pushing indebted firms to sell their assets. The recent examples of corporates who liquidated their assets to pay-off the banks include Jaiprakash Associates and Bhushan Steel. Such measures will provide temporary relief to banks.

However, as reported by Mint, the funds generated from the asset sales are only good to cover the interest cost for around a year. The amount raised is not enough to repay the principal amount on the debt. If that would have been the case, it would have reduced the monthly outgo towards repayment of dues. Thus, the banks would most likely be in a similar situation, say a year from now. This makes asset sales merely a short term solution to the problem.

So what’s the long term solution?

Strategic debt restructuring (SDR) is one way. This scheme allows banks to convert a part of the debt (owed to them by corporates) into equity. The idea with SDR is to convert the weak bank debt into equity and then sell the equity to a new promoter. This enables the banks to recover the money owed to the corporate.

However, turns out that there are certain banks who are misusing the scheme to defer the recognition of bad loans. SDR allows banks to postpone asset classification of a loan for a period of eighteen months. This means that if a loan is in the process of turning into a bad loan, and the bank has converted that into equity, it does not need to categorise that as a bad loan.

Another way of sorting out the problem concerning the recovery of loans is to rapidly resolve the insolvency issue. Resolving insolvency rapidly is essential for banks to recover their loans and for the assets of a failed business to be put to more productive uses. Currently, it takes around 4.3 years to resolve an insolvency issue in India. That’s a fairly long duration. We lag countries such as Bangladesh in this regard. The proposed bankruptcy law will help in reducing this time. Further, credit appraisal process should be tightened to avoid rising bad loans. Unless, changes happen on this front, the situation in the banking sector is unlikely to improve.

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