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5 ways to tackle India’s debt problem
Two of Asia’s largest economies – China and India – face the same problem – bad debt. China’s banks are getting most of the attention, but the problem in India seems to not have improved. 7.6% of the loans offered by India’s banks have turned bad, as of March 2016. This is up from 5.1% in September 2015 and could go up to 9.3% by March 2017, the RBI warned recently.
So in such a situation, what can be done to tackle the bad debt problem? India Ratings, a credit ratings agency, recently published a report suggesting some solutions.
Here are five:
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Asset reconstruction companies (ARCs):
Many companies buy debt or other distressed assets. They repackage this asset and sell it off. Whatever they earn from the sale is used to pay back the debt. ARCs, thus, can play a big role in solving India’s debt problems. “Ind-Ra believes that ARCs have been modestly successful in bad debt resolution in the current paradigm wherein banks have been averse to significant haircuts on debt sales,” the report said. The only issue is that ARCs in India lack the capital to buy the Rs 6 trillion-worth bad debt in the system. Currently, they only have enough capital to buy 10% of the bad loans.
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More capital needed:
To meet these capital requirements, India Ratings suggests that ARCs should be given the freedom to get capital from third-party investors too. This is more so because most of the bad loans belong to large corporates and clients. These loans are often worth over Rs 5 crore. So, restructure such loans, ARCs need adequate funds. Currently, there are many limitations on who can fund such debt restructuring and more importantly, how such debt can be restructured.
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New Bankruptcy Code:
The government has a new Bill in the works – the Insolvency and Bankruptcy Code, 2016 – that can help resolve India’s bad debt problem, according to India Ratings. This can help increase the amount of recovery. Banks and debt companies can recover some amount of the loan by selling off assets. This is called as a ‘recovery’. It is usually measured as a percentage of the original loan value. Currently, banks only manage to recover 30-50% of the total loan value, according to India Ratings. This has the potential to go up to 50-70% if the Bankruptcy Code is efficiently implemented.
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Going concern v/s asset liquidation:
How bad loans are restructured can have a significant impact on the amount of recovery. Banks and ARCs have two options: 1) sell off the assets 2) allow the company to continue its operations and use the earnings to pay off loans. Selling off assets is not always the right option, according to India Ratings. It analyzed four sectors in India that had the most number of bad loans – metal and mining, infrastructure and construction, power, and textile. All four sectors needed the ‘Going concern’ approach, it suggested.
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Realistic haircuts:
The ratings agency also suggested that the RBI should allow banks to have realistic haircuts. When a bank restructures bad loans, it assumes that it will not be able to recover all its money – some portion has to be written off. This loss is called a haircut. The RBI limits how much haircut a bank can take. Often, it is not realistic, India Ratings said in its report.
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86.4%
Large borrowers account for 86.4% of the bad loans in the country, according to a report by the RBI. Yet, they only borrowed 58% of the total loans offered in the country. Each of these large borrowers had debt worth over Rs 5 crore. This shows that a lot of the bad debt problem lies in corporate hands.
