The case for a "Neelkanth" - a bad bank in India

(The following article appeared on CNBCTV18 online on July 29, 2019 - URL below:

https://www.cnbctv18.com/views/why-indias-financial-system-needs-a-neelkanth-to-absorb-poisoned-stressed-assets-4074771.htm )

Delhi, we have a problem

To put it mildly, our financial services ecosystem is no position to fund our growth and investment aspirations. 

Banks are grappling with a large stock of stressed assets. Belying earlier hopes, their recovery and resolution is turning out to be a tortured process. The trust deficit around Non-Bank Finance Companies (NBFCs) assets continues. The health of the broader economy gives little room for comfort. 

We need to break this sense of fear and despondency and reinvigorate the ecosystem. 

First, perhaps we need an empowered, competent, poison-absorbing body – a ‘Neelkanth’ - to quarantine stressed assets away from the ecosystem.  

Second, even after taking away the stressed assets, the ecosystem will need deep structural reforms to break this cycle of churning out poison periodically. 

In this note however, we will limit ourselves to the modalities of a possible poison-absorber. Structural reforms are worthy of a separate debate by themselves. 

Bad wine in a new bottle?

‘Neelkanth’ is a ‘bad bank’ idea, that has been proposed (and shelved) before.

Some of the objections to a bad bank aren’t necessarily valid. Consider the objection that creating a bad bank is tantamount to throwing good money after bad. 

Here are two rejoinders to that. First, between FY15 and FY19, the government has already pumped in INR 2.5 tn of capital into Public Sector Banks. Second, of course deep structural reforms have to be part of any solution set, and we still await them. In short, even without a bad bank, we are currently throwing good money into status quo and hoping for the best. 

However, there are other valid questions around bad banks that need to be addressed. 

·     Should Delhi intervene at all, when the market could raise its own capital and conduct resolution under the Insolvency and Bankruptcy Code (IBC)? 

·     How do we ensure that a Neelkanth doesn’t become another vehicle to extend and pretend? 

·     How do we arrive at the appropriate price for transfer of assets to a Neelkanth? Where do we find the cash and capital to purchase stressed assets? 

·     How do we ensure time-bound and optimal resolution of these assets? 

The study of global parallels can be useful to address these questions. In particular, the experience of Danaharta – the Malaysian Government backed Asset Management Company (AMC) that purchased stressed assets from Malaysian Financial Institutions (FIs) after the Asian Crisis – provides pointers on how India could structure its own Neelkanth.

Putting together a poison-absorber

First, let’s acknowledge that Delhi needs to step in. The IBC route promises much in the long run. But since 2017, we are tying ourselves into legal and financial knots while grappling with our enormous stock of stressed assets. Private capital will not come in sufficient quantity into distressed debt until the IBC process settles down. We scarcely have the luxury of waiting till then.

Given this, drawing from the Malaysia Danaharta experience, here is how our own government-led Neelkanth might operate.

·     Much as with the bank recapitalization exercise, Neelkanth would be initially capitalized by the government, and would in turn hold special government bonds. It could pay for its distressed asset purchases with these special bonds. 

·     Neelkanth could determine a market price for all stressed assets beyond a threshold. Let’s say it determines that INR 50 is the ‘right’ market price for an INR 100 notional stressed asset, i.e. a 50% discount to notional.

·     It would then offer to buy the asset from all FIs at this price. Individual FIs can choose to decline the bid. However, they would then have to provide for and mark down the asset to say 40, well below the bid price.

·     If Neelkanth were to recover INR 80 from the asset over time, i.e., INR 30 more than their purchase price of INR 50, they would return 80% of this surplus (or INR 24) to the original FIs. On the flip side, losses, if any, would stay with Neelkanth. 

Given the carrot of participation in the recovery upside, alongside the stick of higher provisions, FIs would be inclined to dispose of their stressed assets to Neelkanth. 

Other learnings from Danaharta

There are other aspects of the Malaysia Danaharta experience worth emulating.

·     Danaharta wound down by 2005. Danaharta was not a bad bank to perpetuity.

·     Having a government-owned entity as the sole owner of a stressed asset - as opposed to coordinating amongst several individual creditors - allowed for speedier decisions and resolutions, at times accompanied by legislative changes. 

·     Danaharta was manned by seasoned industry professionals, including foreign industry and distressed debt specialists. Every asset was allowed a restructure where viable and liquidated only if all other efforts failed. 

·     It managed an admirable 58.7% asset recovery over time, the highest amongst its Asian peers, and returned cash to the original FIs.

·     Danaharta allowed for a broader consolidation, recapitalization, accountability and structural reform exercise across Malaysian FIs. These FIs then facilitated the country’s remarkable post-crisis recovery. 

Conclusion

We need a way out of the ongoing morass in our financial services ecosystem.

One start could be to revive the idea of a bad bank – a ‘Neelkanth’ – to quarantine and absorb our stock of poisoned stressed assets. Past objections around bad banks can perhaps be addressed, in particular by drawing lessons from the Malaysia Danaharta experience.