Viral Acharya, Deputy Governor, RBI and former professor of economics, NYU Stern School of Business. (Source: BloombergQuint)

RBI’s Viral Acharya Proposes ‘Tough Love’ To Resolve Bad Loan Crisis

Viral Acharya, who took over as deputy governor of the Reserve Bank of India (RBI) on January 20, has suggested fresh structures through which the bad loan crisis facing the Indian banking sector could be resolved, while also calling for dramatic reforms of state-owned banks.

Acharya, who made his first public speech on Tuesday in Mumbai, compared the situation facing Indian banks to the banking crisis that hit Japan in the 1990s and the one that faced Italian banks in 2010. Both crises adversely impacted the respective economies and necessitated centralised intervention to find a solution. Something similar may be needed in India, suggested Acharya.

Gross non-performing assets across 42 listed banks in India have surged to Rs 7 lakh crore as of the end of December 2016, nearly double the amount reported at the end of the September 2015 quarter.

Since the Reserve Bank of India initiated the Asset Quality Review of banks in the second half of 2015, it appears that possibly up to a sixth of public sector banks’ gross advances are stressed (non-performing, restructured or written-off), and a significant majority of these are in fact non-performing assets (NPAs). For banks in the worst shape, the share of assets under stress has approached or exceeded 20 percent. This estimate of stressed assets has doubled from 2013 in terms of what had been recognised by banks. The doubling of stressed assets is the case also for private sector banks, but their ratio of stressed assets to gross advances is far lower and their capitalisation levels far greater.
Viral Acharya, Deputy Governor, Reserve Bank of India

Acharya acknowledged that there has been little resolution of stressed assets. This is despite the fact that the RBI has put in place a number of mechanisms through which bad loans can be resolved. This includes the Strategic Debt Restructuring Scheme (SDR), which allows banks to change the ownership of a stressed asset, and the S4A scheme, which allows banks to convert the unsustainable part of a loan into equity provided at least half the debt is seen as sustainable.

The progress in resolution, however, has been “painfully slow” allowing errant promoters to get away.

“Original promoters – who rarely put in any financing and primarily provide sweat equity – have had somewhat of a field day, facing limited dilution, if any, of their initial stakes nor much of a threat of being outright replaced,” said Acharya while speaking at an Indian Banks Association event.

In Search Of Fresh Solutions

We can choose status quo, but this would be insanity, “doing the same thing over and over again and expecting different results,” as Albert Einstein put it. It would risk a Japanese or an Italian style outcome. Or we can choose to call a spade a spade as Scandinavia did to resolve its banking problems in the early 90s and the United States did from October 2008 to June 2009, even if only after letting a significant bank fail.
Viral Acharya, Deputy Governor, Reserve Bank of India

In seeking a optimal structure for resolving stressed assets in India, Acharya suggested two models – A Private Asset Management Company (PAMC) and A National Asset Management Company (NAMC). Acharya, however, clarified that his suggestions are not akin to creating a ‘bad bank’. His idea is more to create a resolution agency.

  • A PAMC would essentially be a private agency which would work to resolve assets that have economic value in the short run
  • Under the plan, banks would come together to approve a resolution plan
  • They would take on board proposals from a variety of different restructuring agencies
  • These proposals would be vetted by rating agencies to ensure that the borrower’s rating improves post the restructuring
  • This proposal would need to be accepted by a majority of banks and the promoters would have no choice in the restructuring plan being undertaken
  • Haircuts taken by banks under a feasible plan would be required by government ruling as being acceptable by the vigilance authorities
  • Sustainable debt would be upgraded to standard status for all involved banks
There are ways to arrange and concentrate the management of these assets into a single or few private asset management companies (PAMCs), at the outset or right after restructuring plans are approved. These companies would resemble a large private-equity fund run by a team of professional asset managers. Besides bringing in their own capital, they could raise financing from investors against equity stakes in individual assets or in the fund as a whole, i.e., in the portfolio of assets. 
Viral Acharya, Deputy Governor, Reserve Bank of India

While the proposed PAMC may be useful for sectors such as steel and textiles where some sectoral recovery is in sight, the NAMC model could be applied in cases where the asset may appear to be unviable in the short to medium term. The second option, in which the government would play a larger role, may be useful for sectors like power, said Acharya.

  • NAMC would essentially quarantine these assets
  • It would raise debt (which may be government-guaranteed in part) for its financing needs
  • It could also possibly raise debt to pay off banks at a haircut
  • Government may retain a minority stake in the assets
  • NAMC would bring in asset managers such as ARCs and private equity to manage and turn around the assets, individually or as a portfolio
Infrastructure assets that are also long-lived and create externalities (development of townships, improvements in overall productivity, etc.) could be resolved in similar way.
Viral Acharya, Deputy Governor, Reserve Bank of India

When asked whether these were academic solutions or currently being discussed at RBI, Acharya, who doesn’t handle the banking regulation and supervision portfolios directly, said “we have to consider them very seriously. I have no doubt that we can put something together but the solution has to be designed very well”. Acharya noted that world over, large bad loan problems have been resolved only through a collective solution.

Bankers present at the IBA event said that some of these suggestions have already been discussed in parts, while adding that they remain unclear on the government’s thinking on this. The Economic Survey had mooted a different idea of stressed asset resolution which involved the creation of a public sector asset reconstruction agency. The government, however, has not committed to any of these resolution mechanisms.

At very many times we had spoken about this. Many bits and pieces of this had been recommended. Maybe not in the framework in which it was given, but many of this had already been recommended by the banks. Certain things are definitely new. For instance getting a credit rating of the restructured asset is new...So definitely these are under consideration, but how seriously, or what is the government’s thought on all of this, I have no idea.
Arundhati Bhattacharya, Chairman, State Bank of India

Resolving Capital Constraints

Commenting on the need to infuse more capital into public sector banks, Acharya said that while recapitalisation is essential, the government should ask for corrective action from the banks in return. This corrective action could range from a restriction on fresh deposits and loans. Wherever possible, injection of private capital should go together with injection of government capital, said Acharya.

Acharya suggested that healthier banks tap the private markets for capital, even if this capital is being raised at a discount. He also proposed that banks consider raising capital at a banking system level by aggregating assets.

Some banks will have assets or loan portfolios that are in good enough shape to be sold in the market. Assets could be collected across banks and securitised into tranches that are credit-rated, potentially creating some investor demand for buying it at different levels of risk profiles. Such asset sales can generate some of the needed recapitalisation.
Viral Acharya, Deputy Governor, Reserve Bank of India

Acharya also pushed for consolidation among public sector banks saying it is not clear why India needs so many of them. Weaker banks should be merged to create strong ones and voluntary retirement schemes could be used to shed staff, he suggested.

“The system will be better off if they are consolidated into fewer but healthier banks. After all, we do have cooperative banks and micro-finance institutions to provide community-level banking. So some banks can be merged, as a quid pro quo for timely government capital injection into the combined entity,” said Acharya.

Initiating strong reforms for the public sector banking sector, in turn, would allow the government to divest its holding over a period of time, Acharya added and noted that this would reduce the capital commitment required on the part of the government.

I think people need to keep in mind that the government faces other usages for its funds...the government will have to be clever so that its ultimate bill for recapitalisation is not as massive as everyone says it is. I think it is possible to shrink it down.
Viral Acharya, Deputy Governor, Reserve Bank of India