A majority owned arc makes sense

A majority owned arc makes sense

Yes Bank’s reported move to sell its bad loans to a majority-owned asset reconstruction company (ARC) with private equity as co-owners is an excellent idea. The sale of bad loans will free up lending without the bank being burdened by these non-performing assets (NPAs) and, when the assets underlying the bad loans are resolved, the bank will reap profits. This should serve as a model for public sector banks, which are saddled with large quantities of NPAs, to enable them to start lending again to revive growth. Fixing the broken system of intermediation is a priority for economic revival.

PSBs should come together to sponsor ARCs and also rope in private banks that want to join in. This makes sense as the resolution of bad loans takes time. That means entrusting resolution of bad loans to patient capital and experts who can get the most out of the assets placed in their care. Collective ownership of ARCs by banks will ensure the profits made from the resolution of assets underlying a bad loan accrue to them. It would enable banks to offset the loss that they book on selling the NPAs at a discount. But bankers’ fear of being hounded by enforcement agencies for selling their bad loans cheap is not misplaced. So, the need is to get the valuation (and the haircut that banks would need to take) reviewed by an independent body, making it an arm’s-length operation.

This was done in the US in 1988 in the first bad bank experiment that was resoundingly successful. It entailed Mellon Bank of Pittsburgh setting up another bank, Grant Street National Bank, to buy its bad loans and resolve them. The former hired Arthur Andersen & Co to price the loans for sale to Grant Street at a discount, and the price was reviewed by Kenneth Leventhal & Co. Having an oversight committee will offer a shield of integrity to decisions taken by bankers. Indian banks must act fast to unburden their bad loans to ARCs. More competition is welcome. In tandem, deepening the bond market will ensure that long gestation projects can finance themselves with long-term bonds.