Budget lays groundwork to put India’s banking crisis in rearview mirror

Budget lays groundwork to put India’s banking crisis in rearview mirror

MUMBAI: The Union Budget has laid the groundwork to put India’s banking crisis in the rearview mirror as the finance minister Nirmala Sitharaman finally accepted the industry’s long-standing demand for a bad bank.

The finance minister said that the government will set up an asset management company and asset reconstruction company that will take up the bad loans on the books of the banking sector. The move is expected to rid the country’s state-owned banks, which account for close to 70 per cent of the country’s banking loans of the stressed loans that have severely curtailed their growth.

“The high level of provisioning by the public sector banks of their stressed assets calls for measures to clean up the bank books. An Asset Reconstruction Company Limited and Asset Management Company would be set up to consolidate and take over the existing stressed debt and then manage and dispose of the assets to Alternate Investment Funds and other potential investors for eventual value realization,” the finance minister said in her speech.

Prior to the Budget speech today, industry experts had said that taking the asset management or asset reconstruction route for solving the bad loans crisis will be the best approach instead of forming a bad bank with government ownership.

Many details remain to be chalked out that will ultimately show how fruitful the latest effort of the government to clean up the banking sector will be, said analysts. For the time being, investors reacted positively to the government’s move as the Nifty PSU Bank index skyrocketed nearly 8 per cent, while the Nifty Bank index jumped over 8 per cent.

The Reserve Bank of India in its latest financial stability report had said that state-owned banks could see their gross non-performing assets ratio deteriorate to 16.2 per cent in the baseline scenario and 17.6 per cent in the worst case scenario by September 2020.

At the end of the September quarter, the gross NPA ratio of state-owned banks stood at 9.7 per cent.

Analysts said that if the bad loans are taken off of the loan books of state-owned banks, it could trigger a sharp re-rating in the sector as investors may start pencilling in better growth prospects. More crucially, it will help state-owned banks flex their lending muscle once again.

“The positives are, of course, you will be able to clean up the balance sheet and once they are recapitalised, you will be able to focus on growth and provide capital to the economy,” said Pramod Gubbi, co-founder of Marcellus Investment Managers.

Money managers believe that a capital-starved economy like India needs the banking sector firing on all cylinders to fund the increased need of capital in sectors like infrastructure. With the government aiming to boost infrastructure outlay by Rs 100 lakh crore over the next four years, state-owned banks will be required to provide a helping hand.

However, money managers cautioned that the details of the ARC and AMC to be set up by the government need to ensure that it does not create a bad precedent in terms of incentives. Analysts believe that the government needs to make sure that banks do not interpret the setting up of a bad bank as a licence to continue the lax loan policy that the industry saw in the aftermath of the Great Financial Crisis in 2008-09.

Further, some investment managers suggested that the fine print of the ARC and AMC should include a clause that allows banks to plow back any excess recoveries from the asset sale by the asset reconstruction company so as to minimise the loss taken by minority shareholders since the banks.

“Hopefully, this is the last time we have to do this…but we need to be very careful to not set the wrong precedent,” Gubbi said.

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