Make banking stress less distressing

Make banking stress less distressing

Banks have reportedly been forced to put bad loans worth ₹40,000 crore on sale in the first half of FY20 following delays in the resolution process under the Insolvency and Bankruptcy Code. This is pragmatic. It is faster for banks to sell their nonperforming assets to asset reconstruction companies (ARCs) that can take up the resolution of bad loans, enabling banks to clean up their books. However, banks would have to take huge haircuts as ARCs would buy the underlying distressed assets at a steep discount to the replacement cost. And the banks would need to be given extra capital to underwrite the losses.

The remedy is to create a competitive market for distressed assets. It would lower the losses that bank would take, improve the price of the distressed asset on sale and help investors make profit when the company turns around. The need is to create more financial investors that include retirement funds for the country to get pools of patient capital to buy-out stressed assets. In the US, for instance, huge gains were made by specialised buy-out funds that had revived distressed companies. Just as private equity buys stressed assets, there is a strong case for retirement funds such as the National Pension System and the Employees’ Provident Fund, which manage the retirement savings of civil servants and private sector workers, to set up special funds to bid for these assets, given the huge opportunities for an upside. The windfall gains would be widely shared by the public, instead of being cornered by a tiny elite.

The banks could together set up buy-out funds, too. These could hold the distressed assets, turn around those that can be turned around and sell them off at a profit that would be shared among the banks. Bold innovation holds the key, in either case, to tackle the burden of distress on banks’ books.