The very BAD idea of a Bad Bank

The idea of a "Bad Bank" as a solution to India's large bank NPA problem isnt new. Its been around for many years, discussed, implemented in parts (through different experiments of Asset Reconstruction Companies, ARCs). But recently, the idea received some high level policy support, when the CEA Arvind Subramanium wrote an entire section of the Economic Survey on the idea, essentially saying "its an idea whose time has come". Now, while Victor Hugo might disagree from his grave, but this is one idea against which all powers must be used, even if its time has come. Simply because its a really bad idea - structurally, conceptually and implementation-wise. How? Read on...

What are the basic parameters of resolving a bad loan (NPA) issue? As practising bankers (as opposed to many Central Bankers, and most/all journalists/academics) would instinctively know, it consists of 4 basic rules:

One, estimating and affecting a haircut on the loan amount, in order to make the underlying operating business viable, and able to service the loan.
Two, a turnaround plan for the business that extracts maximum value for the bank - both on loan recovery as well as potentially on the equity that replaced the loan haircut taken. This includes changing promoters, structuring, legal etc.
Three, immediate capital to enable the bank absorb the haircut.

Four, specialist bankers with the skillsets to carry out #1 and 2.

Why has India's NPA issue been so intractable? Very simple - there are structural impediments to #1 and #4 above.

One, thanks to the scourge of the 3 Cs (CBI, CAG, CVC), public sector bankers (PSB) have been loathe to structuring haircuts for any of the loans gone bad, or under stress. They have found it a lot easier to simply evergreen the liability - in simple language, leave the problem for their successors to resolve. As a result, a stressed loan of (say) INR 100, after unpaid interest, interest on interest, fines on delay on interest payment, balloons to double or even more by the time someone starts taking action. The storied Kingfisher Airline is a case in point - of both bankers evergreening the loan for years, as well as refusing a sensible haircut-backed settlement. 

Secondly, bank recapitalisation has progressed in wholly inadequate quantums. Nifty acronyms (like INDRADHANUSH) has been hilariously tried in lieu of adequate capital being injected. Thanks to depressed valuation levels (as well as lack of investor appetite), it has been impractical for banks to tap capital markets for equity capital.

How does a Bad Bank (BB) resolve any of the above two issues? It doesnt. A govt-owned BB would simply be a case of "left pocket right pocket", both in terms of capital as well as in terms of enabling operating environment (3 C's). A private sector BB would have moral hazard questions (for example, at what value would be buy the NPAs from the existing banks?) that would compound the 3 C's related issues for PSBs.

We have no dearth of #4, ie, bankers who know the industry domain and can come up with solutions. Over the years, the legal-regulatory architecture for #2 - creating new lending structures, knocking off promoters, bringing in specialist managers - have also become a lot more conducive.

And there lies the nub of the real solution. As Mark Antony remarked, "the fault, dear Brutus,is not in our stars, but within ourselves". The issue is within the government - a 3rd party structure isnt going to help. A large dose of capital (good news - demonetisation has injected part of it into balance sheets), financed through any of the many clever ideas long debated (RBI reserves, SPV, Bank HoldCo listing etc) will be a first step. Taking PSBs off the category of "public servants", and hence taking them away from the ambit of the 3 C's, will complete the enabling circle. This will free up banker energies towards searching for pragmatic, real solutions, ring fence them from much-abused and uninformed criminal investigations and incentivise true problem-solving.

Talk is cheap, acronyms cheaper, and bad ideas have negative value. The government should concentrate on walking the real talk now - there's been enough of talk/acronyms/bad ideas!