Public Sector Asset Rehabilitation Agency (PARA)

The Public Sector Asset Rehabilitation Agency (PARA) colloquially called “Bad Bank” is a proposed agency to assume the Non-Performing Assets (NPA) of public sector banks in India and to deal with the recovery of the bad loans. This agency has been proposed in Economic Survey 2016-17.

The NPA Problem

At end-September 2016, the NPAs of public sector banks stand at 12% of the gross advances. At this level, India’s NPA Ratio is much higher than any major emerging market {except Russia}. This has resulted in a squeeze on the banks leading them to slow credit growth. The slow credit growth is not good for industries, particularly MSME sector. The continuous fall in credit growth to industries has resulted in overall negative investment.

Twin Balance Sheet Problem (TBS)

The problem of bad loans is compounded by another problem of overleveraged corporate; and these two combine to create India’s twin balance sheet problem. On the one hand, the public sector banks are burdened with the high non-performing assets (NPAs) while on other hand, some of the corporate houses are also under stress due to sluggish global demand and overleveraged borrowings. This has been called the “TBS problem” or “Twin Balance Sheet Syndrome“.

Current Institutional Framework around Bad Loans

The major components of the current framework around NPA are

• SARFAESI Act
• Asset Reconstruction Companies (including private companies.
• 5:25 scheme
• Strategic Debt Restructuring (SDR)Scheme

SARFAESI Act

The Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest (SARFAESI) Act provides for the banks to take legal recourse to recover their dues. Under this act, when a borrower defaults the payments, the banks can take possession of the assets and can also give it on lease or sell it.

Asset Reconstruction Companies (including private companies

If the NPA remains so for more than two years, the bank can also sell the same to Asset Reconstruction Companies such as Asset Reconstruction Company (India) (ARCIL). This apart, the private Asset Reconstruction Companies(ARCs) under SARFESI Act 2002 were established so that the banks can remove focus from NPAs and focus more on their main business. However, ARCs purchase the bad loans in too cheap prices and banks are unable to accept their offers.

5:25 scheme

In June 2014, RBI had launched a 5:25 scheme under which the creditors were allowed to increase debt period up to 25 years with interest rates adjusted every five years. But since it is a long duration, the companies find it difficult to endure high interest burden, thus forcing banks to infuse additional grants thus leading to problem of “evergreening of loans”.

Strategic Debt Restructuring (SDR)

RBI had launched the Strategic Debt Restructuring (SDR) scheme in 2015 under which the banks could take over firms  that were unable to pay; and subsequently sell them to new owners. This scheme also has not been much successful so far.

Different Approach

The economic survey suggests that these approaches have limits and for remedy, there is a need to consider a different approach. Under this approach, a central agency called “Public Sector Asset Rehabilitation Agency” should be established.

Working of PARA

The main function of PARA would be to take charge of the largest, most difficult cases, and make politically tough decisions to reduce debt.  The funding of this body would come either by selling the bonds or by inviting private companies to buy its equities. The survey also suggests that instead of investing funds and recapitalize the banks year after year, it would be better for the government to focus on recovery.

Comment and Conclusion

Since banks may remain risk averse in the near future as they clean up their balance sheets and their capital position may remain insufficient to support their higher credit growth. The problem is obviously more severe for PSBs since they have the most stressed books. The only possible solution is a bad bank that takes over the toxic debt of PSBs and leaves behind a good bank that can freely lend. The solution is not without problems since with the bad loans off their books, banks can get reckless with lending again. The alternative, though, is that, with PSBs unable to lend fast enough, private banks will take their place- that’s privatization by stealth, with the government not even benefitting by the way of selling off PSB equity.