Governance and Policies

A first step: Ordinance empowering RBI to direct banks to resolve bad loans should end current paralysis

Credit is the lifeblood of a modern economy. When primary dispensers of credit, banks, struggle the fallout encompasses the entire economy.

May 8, 2017
Credit is the lifeblood of a modern economy. When primary dispensers of credit, banks, struggle the fallout encompasses the entire economy. India’s banks, particularly public sector banks, have for a few years struggled to cope with the weight of bad loans which originated during last decade’s boom. Consequently, attendant problems such as high risk aversion have choked the flow of credit. The Modi government is alive to this problem and has tried to deal with it. Last week it promulgated an ordinance which amplifies RBI’s powers to direct banks to find solutions. It is a welcome step.
The ordinance gives RBI powers to unilaterally direct banks to resolve bad loan problems. Additionally, government can authorise RBI to initiate insolvency proceedings against defaulters under the new bankruptcy law. On Friday evening, RBI exercised powers granted by the ordinance to reform existing processes for resolution of bad loans. It is an important first step as these mechanisms are functional and can produce results if flaws are ironed out. It may seem underwhelming in relation to expectations. But it won’t be the only step.
As finance minister Arun Jaitley pointed out if some of the largest stressed asset cases are resolved, it will create space for banks to step up lending. On the other side, this step may salvage some economic value in troubled companies. The primary aim of the first step should be to end the current state of paralysis on account of coordination problems among bankers and their fear of witch hunting by enforcement agencies trying to discern motives in a commercial decision. In this context, it is important to keep in mind the ordinance is not a full solution.
That requires other changes, including amendments to the legislation which aims to prevent corruption so that good-faith decisions without proven quid pro quo are not penalised. Government is also keen to link the next round of capitalisation of public sector banks to governance reforms. The ideal reform will be for government to give up ownership of banks as repeated bad loan crises have exposed inherent flaws of state control. This ordinance should be seen as a short term measure as RBI, the banking regulator, needs to quickly distance itself from operational decision making of banks.
Read More:
Times of India, May 8, 2017

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