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Jehangir S. Pocha
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It’s time to talk about the bad loans scam

Rs 75,000 crore will disappear under the innocuous entry of ‘bad debts’ this year.

staggering Rs 2.5 lakh crore of public money has been lost by India's public sector banks. The extent of these "bad loans" is greater than the loss to the exchequer from the 2G scam (Rs 1.76 lakh crore) or Coalgate (Rs 1.86 lakh crore). Yet, no one is talking about this. Worse, the bad loans scam is continuing to unfold. Another Rs 75,000 crore will disappear under the innocuous entry of "bad debts" this year, says rating agency Icra. With that, 5% of the loans made by Indian banks will have gone bad. In layman's terms, this means the balance sheets of most public sector banks are in as much of a shambles as their branch offices.

Previous Finance Ministers Pranab Mukherjee and P. Chidambaram perfected the art of ignoring the problem. They stayed silent on the issue and when pressed spoke about bad loans only in vague, inconsonant terms.

That fuelled speculation that many bad loans were not just the result of bad business decisions but bad intent — that businessmen in cahoots with politicians, bankers and bureaucrats have been looting public sector banks merrily. After all, the rate of bad debt in government-owned banks is about 5-10 times higher than in private banks. Partly, this is because PSU banks lend more to the weaker priority sector. But it is undeniable that poor management and corruption are also major reasons public sector banks are bleeding.

Think how easy it can be to milk a public sector bank. A businessman concocts an alluring business plan and bank officers use it to sanction him a loan. The loan is then split between them with the required cut getting passed up the line. In time, the loan is declared bad and never repaid. 

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Centralisation of all bad debts in a new “bad bank” would make them easier to manage. Recovery of loans could be pursued more aggressively, as the bank managers who made the loans would be out of the way.

The new government is so focused on its 100-day performance that it has not applied its mind to the problem. But easy solutions exist if there is the will to pursue them. The government can set up a new institution dedicated to managing bad loans. It can then get banks to "sell" their bad debts to this new institution, which is colloquially called a "bad bank". The debt could be transferred on payment of, say, 10 paise on the rupee i.e. banks would "sell" a Rs 100 crore bad loan to the new "bad bank" for Rs 10 crore. So the transfer of Rs 2.5 lakh crore in bad loans would need an allocation of only Rs 25,000 crore in the upcoming Budget.

With this, the government could kill three birds with one stone. The "sale" of bad debt would infuse much-needed new capital into the banks. This is something the government needs to do anyway because of the advanced capital requirements under Basel-III norms. It would erase all the bad debt weighing down public sector banks' balance sheets and free them to merge with other banks or raise more capital from markets. This in turn will force banks into adopting more transparent and prudent procedures and force them to stop unviable, politically directed lending.

Lastly, the centralisation of all bad debts in a new "bad bank" would make them easier to manage.

Recovery of loans could be pursued more aggressively, as the bank managers who made the loans would be out of the way. The government could also slowly write off the really bad loans over a period of, say, 20 years. That would require just about Rs 10,000-12,000 crore a year, which is manageable. This is essentially what China did when its government-owned banks were saddled with some $400 billion in bad debt during the 2000s. Once these bad debts were swept off the balance sheets of Bank of China and other banks, they listed themselves on the Hong Kong stock exchange and went on to become world leaders. India can do the same but the ease of the solution is exactly what worries some, like economist Ajay Shah. "If you make the solution easy the problem will keep recurring," Shah says.

This is why the new government must also seriously investigate any fraud in bad debts and punish the bad boys behind them.

The Reserve Bank of India must also be held culpable for its loose liquidity policy. Excessive money creation in 2006 pressured banks to lend more to less than solid businesses. RBI's own laxness in tamping down on bad lending practices also allowed the problem to swell.

Lastly, India's infamous bankruptcy rules also need to be overhauled. Quicker, cleaner closures and forfeitures must be permitted so ailing companies do not keep borrowing more to stay afloat and turn into bottomless pits. If the Narendra Modi government expends some of its political capital on this, it could end one of India's most insidious corruption schemes and turn public banks into real engines of growth.

 
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