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At the Public Expense

Why should the financial distress of the private corporate sector be borne by the public sector?

The Banking Regulation (Amendment) Ordinance, 2017, promulgated on 4 May 2017, amends the Banking Regulation Act, 1949 to authorise the Reserve Bank of India (RBI) to direct banking companies to initiate insolvency resolution processes with respect to defaults, under the provisions of the Insolvency and Bankruptcy Code, 2016. Additionally, the RBI may “from time to time, issue directions to banking companies for resolution of stressed assets,” and may appoint committees to advise banking companies. It remains unclear what this ordinance seeks to achieve, given that the RBI already has oversight over banking operations, and can issue directions to banks with the powers already vested in it by the Banking Regulation Act, 1949. It remains to be seen whether this amendment will result in a faster resolution of stressed assets. The government and its functionaries, nevertheless, continue to suggest measures that seek to find quick fixes to the stressed assets problem. Essentially, these solutions seek to force ways to ensure that the costs of private-sector loan defaults are borne by the state and its enterprises.

Various measures have been suggested in the recent past. The Economic Survey proposed the creation of a Public Sector Asset Rehabilitation Agency (PARA) which would purchase the bad loans from the public sector banks (PSBs). The proposed PARA would be financed from three sources: the issue of government securities, equity shareholding by private investors, and money from the RBI’s surpluses. Like the PARA, the other proposed solutions to the stressed assets problem also rely on state financing to clean the financially-distressed banks’ balance sheets. What is worse is a reported meeting (in the presence of the Prime Minister) at which it was proposed that the public sector undertakings (PSUs) be “coaxed” to purchase the non-performing assets (NPAs) of the banks’ private corporate sector (PCS) loan defaulters. To conjecture, in effect, such a transfer of stressed assets to non-banking PSUs will not attract the level of scrutiny that PSBs dealing with the PCS debtors would. The PCS debtors would sell their bad assets and pass on the corresponding liabilities to the PSUs, in turn, rendering the cash-rich PSUs financially distressed. Why not instead just recapitalise the PSBs and hold the PCS defaulters to account?

Recapitalising PSBs is spoken about in the same vein as providing budgetary support to loss-making PSUs. Such a presentation is a distortion of the truth. The PSBs are profitable entities that contribute significantly to tax and non-tax revenues, and have, for instance, contributed more to the exchequer during the period 2005–06 to 2016–17 than the budgetary support they have received. The clamour to reprivatise the PSBs rests on the false assumption that mismanagement is primarily responsible for their current high NPAs-to-gross-loans ratio, and that if there was more business space for private banks, this would not be the case.

Such a view ignores the pattern of investment and growth that was witnessed over the last decade. High growth accompanied liberal lending across the board, but then, the global financial crisis of 2007 led to a general slowdown of economic activity. This meant lower profits and higher defaults, especially in the infrastructure-related companies of the PCS. Even as there were cases of poor lending decisions by the PSBs, the primary cause of the banking crisis lay outside the banking system and its management. Unlike private banks, it was the PSBs that were pressurised by the government to take a high exposure to corporate clients in infrastructure-related areas such as power, steel, telecom and aviation. The private banks were simply not willing to assume the risks of a high exposure to such infrastructure projects, given the latter’s huge capital outlays and long gestation periods.

Clearly, the choice before the government is the following: either recapitalise banks even as debt recovery processes are underway or find ways to improve their balance sheets by shifting the bad debts off their books. Of these two options, the second is a quick fix. Here too, it would be the state that would bear the costs. It would allow the private corporate defaulters to get away with little scrutiny and possibly better deals in the restructuring of their debt, with some of that debt written off. North Block must, however, surely be apprehensive that, if the PSBs are directed to restructure or write off substantial amounts of debt, these decisions will attract far too much public attention and will expose the government to the charge of favouring its cronies in the corporate world. It might therefore suit the government’s and its cronies’ interests if they were to resort to debt resolution outside the banking system and the public gaze by “coaxing” the PSUs to buy the stressed assets of the financially-distressed PCS companies and take on board their associated debt liabilities.

Updated On : 15th May, 2017

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