Note4Students

Economic Survey 2017 mentioned a new institution PARA (bad bank) which could be utilized to solve the Twin Balance concept. Since it was a controversial institution it has raised debate among experts. A number of op-eds both in favour and against have been written against this proposed Institution. Therefore, we find this topic as a probable topic for mains 2017

Context

The latest Economic Survey has mooted a new idea, PARA, as a solution to the NPA problem.

What is PARA?

1. The Public Sector Asset Rehabilitation Agency or PARA will be an independent entity that will identify the largest and most vexatious NPA accounts held by banks, and then buy these out from them.

Need for PARA?

1. To resolve bad debts on sound economic principles
2. Stressed debt is concentrated in larger companies. Bigger cases are difficult to resolve and needs an independent agency.
3. Banks have difficulty in solving these cases due to lack of coordination, capital etc. Even private ARCs have failed. International practice has shown PARA like organization to be viable to solve TBS problem. E.g. Post East Asian crisis
4. Many of the companies are unviable at current level of debt requiring debt write-downs in many cases.
5. Immediate step is needed because delays are increasing the problem

Ill effects of NPA on the Economy

1. Lenders suffer lowering of profit margins.
2. Stress in banking sector causes less money available to fund other projects, therefore, negative impact on the larger national economy.
3. Higher interest rates by the banks to maintain the profit margin.
4. Redirecting funds from the good projects to the bad ones.
5. As investments got stuck, it may result in it may result in unemployment.
6. In the case of public sector banks, the bad health of banks means a bad return for a shareholder which means that government of India gets less money as a dividend. Therefore it may impact easy deployment of money for social and infrastructure development and results in social and political cost.
7. Investors do not get rightful returns.
8. Balance sheet syndrome of Indian characteristics that is both the banks and the corporate sector have stressed balance sheet and causes halting of the investment-led development process.
9. NPAs related cases add more pressure to already pending cases with the judiciary.

How will PARA work?

It would purchase loans from banks and adopt value maximizing strategy to solve them. E.g. Converting loan (debt) to equity etc. Then the government can recapitalize PSBs.  In this process, losses would have to be paid to the creditors.

The bulk of this burden will fall on government as PSBs are major creditors.

The government can finance this capital by –

Issuing Government Securities.

Capital markets – Private sector can take equity floated by PARA. Government can sell its holdings in PSBs too.

RBI is one of the most highly capitalized banks in the world. Therefore, its excess capital like securities can be transferred to PARA.

International Experience

Issues/Challenges With Bad banks:

Worsen Macroeconomic stability

creation of a bad bank puts a strain on government finances in the short term. Even if the government funds only 20% of stressed assets in the banking system, it would exceed the net market borrowing target in 2017-18 by more than 30%. Achieving committed targets for fiscal deficit and government-debt-to-GDP also becomes difficult for the finance minister.

2. Who will have the majority stake in the bad bank? Will it be the government or private investors?

3. A big chunk of NPAs at PSBs pertains to projects that are viable.

4. Why would taxpayers’ money be used to buy bad loans of private sector? It would be socialisation of the losses of the private sector” who can pay but are not willing to pay.

Way Forward

Set up a bad bank to deal with NPAs at some of the weaker PSBs, instead of one that picks up NPAs from all PSBs.

It would prove less controversial if the government had a majority stake in it.

This must be complemented with other steps.

1. The government must infuse more capital into the better-performing PSBs.
2. It must also create, through an act of Parliament, an apex Loan Resolution Authority for tackling bad loans at PSBs. The authority would vet restructuring of the bigger loans at PSBs.

Conclusion:

Resolution of bad loans and restoring the health of PSBs is among the biggest challenges the economy faces today. It’s a challenge that requires a response on multiple fronts. A bad bank cannot be the sole response.

Question:

Q.1) To solve the Twin Balance problem, Economic Survey has suggested setting up of a Centralised Public Sector Asset Rehabilitation Agency. Critical discuss whether setting up of an agency like PARA will be feasible?