Indian finance minister Nirmala Sitharaman announced a huge $500bn budget on February 1, focused on healthcare and infrastructure and aimed at boosting the country’s Covid-19 ravaged economy.
During her speech, she also committed the Indian government to forming a ‘bad bank’, in an attempt to tidy up the country’s struggling banking sector.
India’s banks entered the pandemic in poor shape and Reserve Bank of India stress tests suggest the sector’s non-performing loan (NPL) ratio could surpass 13% this year. This represents one of the greatest NPL burdens anywhere in the world.
The bad bank’s primary focus would seek to deal with NPLs by purchasing them from commercial banks and then restructuring them.
“[The bad bank] would help to strengthen the balance sheets of commercial banks, boost capital adequacy ratios and allow them to focus on new lending, which has been weak for several years,” Shilan Shah, senior India economist at Capital Economics, wrote in a report published on February 5.
Bad banks have been effective tools in cleaning up financial sectors in a number of countries over the past few decades, including Sweden, Nigeria and Vietnam.
50 companies account for 30% of stressed assets
In India, the formation of a bad bank could be particularly beneficial given that just 50 companies account for 30% of stressed assets, Mr Shah wrote. “These companies have debt spread across many banks. If the debts were consolidated in one place by a bad bank, their resolution would be easier to coordinate.”
The bad bank is expected to be run by the private sector, although Mr Shah said such a move could make it harder to reach agreements on the price of loans.
A bad bank only helps to deal with the symptoms rather than the cause of banking sector problems
“A privately-owned bad bank would only purchase NPLs at heavily discounted values. That means that large capital injections for banks would still be required to improve balance sheets,” he wrote.
India’s finance ministry has set aside funds of about $3bn to be invested in public banks over the next year, but as NPLs at public banks stood at more than $90bn before the crisis, the figure “represents only a fraction of what is needed”, according to Mr Shah.
“A bad bank only helps to deal with the symptoms, rather than the cause, of banking sector problems,” he added.
“Privatisation and stronger governance would help to boost competition and reduce political influence, which would trim the likelihood of banks making the poor lending decisions that led to the NPL problem over the past decade,” wrote Mr Shah.