Ideas to fix the twin balance sheet problem

A lot of loans that Banks in India (public sector banks in particular) have lent to big business projects are turning out to be bad loans. This implies that many of these businesses are not in a position to pay back these loans because the projects for which they took the loans are not quite viable anymore or facing business challenges. The banks consider these loans as assets but when loanees are not in a position to pay back these loans then these assets becomes “non-performing” or when they become risky then they are called “stressed assets”. These loans were given/taken during the high growth period starting around 2008–09.

As per March 2016’s data following are the key indicators of the scale of the problem.

• Stressed assets — commercial banks = 11.5%; for PSB = 14.5%. Overall = 12 %
• NPA overall ~= 8%. PSB ~= 10%

More recent data suggests that this problem has gotten worse clocking:

• NPA = 6.8 Lakh Crores.
• Stressed assets = 12 Lakh Crores or whopping 8% of GDP

Also, in 2017 these numbers climbed further in the wrong direction.

This has led to what is referred to as twin balance sheet problem. On one hand banks are unable give out more loans because they need money to compensate for non-performing assets. On the other hand businesses, because of high debt accumulation and interests to be paid to the bank, are unable to finance new business projects. This lack of credit and new investments can have (and arguably is already having) slowing impact on the GDP of the country by impeding the overall economic activity.

Solutions put forth by economists and commentators

There are some salient aspects of (important learnings from) this crisis that are making it difficult to resolve this problem.

• The business projects have taken loan from multiple banks. This makes it difficult for an individual bank to go single handedly to the market and try to find buyers for these assets. It requires coordination among multiple parties.
• Unwillingness on the part of the bank to take significant losses when restructuring the debt.
• The bank officials are afraid of restructuring the stressed and non-performing loans for the fear of vigilance, audit and investigations.
• By definition the scale of the loans involved are very big and it is not easy for the government to simply finance this from its own budget. Also, there are potential political fallout of this.

RBI/Government has tried the following so far to resolve this problem but they have been found wanting:

• Rescheduling of the loan tenure
• Encourage asset reconstruction companies to buy up bad loans
• Strategic Debt Restructuring Scheme — encouraging creditors to take over the firms
• Infusion of funds by the government to the banks

So the main issue still remains - India is indeed facing a twin balance sheet problem that needs to be resolved. Given this let us look at the solutions being proposed so far:

The first set of recommendations come from Viral V. Acharya, Deputy Government of RBI. This appears to be a value maximisation strategy and he proposes…

1. identify the assets which have lesser but meaningful potential value in the market and resolve these assets by restructuring these loans and selling these assets to the buyers in the market. During this process the interest of promoters need not be kept in mind and the solution is to be determined by the market. Some centrally empowered authority should allows for immunity from vigilance officials. Specialists not having a conflict of interest should be heavily to be used in process.
2. There are projects/assets that do not have market value in short and medium term, but likely to be valuable in long term. In such cases one should aim for asset recovery in long run. For such projects — one should essentially raise long term debt to finance the purchase of such assets. When these projects start making money in long run, pay back the debts using that. Government to act as a guarantor for such debts.

The second set of recommendations come from Economic Survey, chapter 4, vol 1. This is based on loss minimisation strategy.

1. Economic survey argues that market mechanisms and decentralised approach both have failed because of the incentives involved (listed as salient aspects above). Hence the recommendation is go for a highly centralised approach.
2. Set up a centralised agency responsible for resolving only the really large and complex loans. This proposed centralised agency will not have the problem of coordination, lack of decision making for the fear of investigation.
3. Purchase the loans from banks and follow a value maximisation strategy for these loans by involving an external competent private agency. Fund the banks simultaneously to the extent needed for them to get back to business as usual of funding the creditors.
4. Sell down holdings of the government in some of the banks.

The ideas from left are as follows:

• Banks should take over the management or effect required change in the businesses using existing laws in place. (This idea stops short of what one should be done after that)
• Government and RBI should not get involved in trying to resolve the problem as there are existing laws which should be used to resolve this.
• CBI should go after the dishonest bankers.

But who bears the cost?

While the resolutions above are important, it does raise the issue of — who bears the cost of these. Here there are few considerations — how to share the cost between government (representing the public), banks and businesses. In this regard following suggestions have been made:

1. The banks should also float some of their good assets in the market so that the restructuring has some market rationale behind it.
2. Use the opportunity to consolidate many public sector banks into a few number of banks, so that better management can be put to use more efficiently.
3. Government divests its share in some of these banks.

My thoughts on most effective way of resolving this crisis

The most important thing to understand is that there are no clever ways by which the financial liabilities of the government (via banks) will simply go away. Financial loss is inevitable at this stage. Secondly, finding solution that allows us to move forward (solve the twin balance sheet problem) with most efficiency and least loss should take precedence over finding/punishing those responsible for this mess. Punishing those responsible will be a good idea too, but I am not sure given the political economy we would be able to reach there. Lastly, there will be inevitable loss of some political capital for the governing political party.

With that context in mind I am picking most effective way of getting us there which is really a combination of ideas proposed so far (or even an all of above, minus some, type of approach):

1. Take a highly centralised but market validatable approach. A central authority must be created that is responsible for this task. The authority should make maximum use of the private entities (to also avoid the problem of politics, discussed later) as the decentralised approaches are prone to:

• Diffident decision making because of lack of authority and large size of some of the deals
• Difficult to instil a sense of urgency and clearly communicate the essential principle driving the solution

2. The non-performing and stressed assets should be put under three categories (adding to the deputy governor’s idea above).

• Assets with short term value
• Assets with less short/medium term value because of lack of demand but potential value in future based on the projected update in demand.
• Assets that are perhaps junk

The short term assets and long terms assets should in principle be dealt with as prescribed above. This strategy allows for getting maximum value from these assets. The assets that are junk should simply be auctioned for whatever value one can get.

3. Restrict the scope to only top 50 assets. This will be effective for the following reasons:

• The authorities will not be stretched in their capacity having to deal with low value assets.
• The remaining assets could be left to the individual banks to deal with in a regular manner.
• Let the private commercial banks deal with their own problems, except when a particular asset overlaps with the assets of the commercial banks. The commercial banks otherwise have the required capacity to handle their NPAs and stressed assets on their own.

4. A centralised government authority is also likely to result in hyper-politicisation of the issue. This is mainly because the public sector banks will be making losses as result of lowering of the overall original value of the loans. This is most likely to be projected by opposition as doing favours to corporates and causing loss of public money. Following political approach could be taken to get around some of this:

• Since assets will be by being sold in the market it can be projected as using a transparent process and not doling out favours.
• The fact that the government has taken control of the private assets could also be used to counter the usual opposition’s narrative.

This leaves an important and genuine political/democracy question — the political parties take funding from these corporates, there is an inherent deeper conflict of interest in India that goes beyond the issue of NPAs. But I will submit that unfortunately not much can be done about it within the scope of this particular resolution — without derailing it.