The need for off-loading the non-performing assets of public sector banks was highlighted by former Reserve Bank governor, Raghuram Rajan. He had also prepared a blueprint for setting up a new entity to take over bad debts of public sector banks to restore their balance sheets to good heath. The bad debts portfolios were dragging down the banks’ balance sheets.

The way the new bank is supposed to function is that the NPAs of banks would be transferred to the new bank, against which the transferee bank should get securities from the government worth 85% of the NPA value. The balance amount of bad loan, 15% would be given to the bank in cash.

From what has been announced so far about the mode of functioning of the new bank, it is not clear how exactly the whole chain of adjustment should be. In case a bad debt is transferred from, say a PSB, who will bear the cross. But there is no doubt that the public sector banks will be much relieved with this.

This approach would protect the banks as they do not have to declare these NPA as “unrecoverable” and provide for the loss on their account. So the banks balance sheets would radically improve the moment the bad loans are transferred.

The government had also announced a corpus of fund —Rs30,500 crore — as a backstop facility to guarantee the recovery of the bad loans. However given the volume of bad debts of banks this amount looks puny.

The entity taking over the bad loans would pursue these assets and seek to recover the full amount in due course, hopefully. The question is if they fail to recover the amount in full, who will finally book the loss on account of non-recovery.

Alternatively, if there are haircuts on the loans, how will these be accounted for. Will the bad bank carry these and adjust against the fund announced by the government or the bad bank will have to recover from profitable recoveries on her loan accounts.

In some ways, the government will have to carry the loss on account of bad loans, it appears. Since the government will offer securities upfront, these will possibly be out of budget operations.

Presumably, these ideas have been taken forward from the days of Raguram Rajan during his tenure at the RBI. Rajan is a professor of finance in the Chicago Booth School of Management. Hence the entire approach towards resolving the bad debts problem is financial in its approach, that is, financial juggleries and layering of the debts at successive stages.

The origins of the bad debts were at the corporates engaged in infrastructure building or steel production or some other industrial activity. RBI studies had revealed that bulk of the bad loans originated in the infrastructure sector companies and steel manufacturing companies.

The ultimate resolution of bad debts lies in restoring the besieged real economy entities to health and keeping these in good shape. Industrial sickness gets reflected in financial insolvency in the later stages, which are thereafter shown in the stained bad debt portfolios of commercial banks.

So then, the current approach to resolution of bad debts of banks is financial in nature. But much earlier, when the economy was plagued with widespread industrial sickness, efforts were made to correct the health of the industrial entities.

Most people may not recall, however, India had a bad debts banks decades back. The Industrial Reconstruction Bank of India (IRBI) was set up about four decades back and it was headquartered in Calcutta. It did function as a bank for taking over the non-performing assets of the public sector banks.

In those days, the bad debts were mostly of sick industrial and manufacturing companies. That was because India still had large number of manufacturing units, producing any number of products in a sheltered market protected by high tariff barriers.

The sick assets of those days were mostly manufacturing units, belonging to the big industrial houses of the country. Many of the se NPAs were the rest of lethargic management which had failed to anticipate development of the market or new technology which had rendered existing products and product lines obsolete.

The IRBI was eventually wound up for a number of reasons including the fact that sickness was too prevalent for the problem to be addressed by a single repository for bad loans. There were no other such entity to take over sick units and their assets.

Secondly, the approach was to take over a company having the sick assets. Thus entire companies were taken over and their managements were changed or were entrusted with the new bank. It was therefore too much for the IRBI to manage a plethora of bad companies.

Thirdly, IRBI had ran into problems of finding enough low-cost funds to carry out its remit. The bank had to obtain funds at lower than prevailing market rates and the funding sources had dried up after a while.

Thus the reconstruction bank, which was supposed to recover monies locked up in non-performing assets, had outset become a dead loss. It was wound up with out much ado. (IPA Service)