RBI’s Relief to the Banking Sector

The following article is based on my own interpretation of the said events. Any material borrowed from published and unpublished sources has been appropriately referenced. I will bear the sole responsibility for anything that is found to have been copied or misappropriated or misrepresented in the following post.

Abhishek Barui, MBA 2015-17, Vinod Gupta School of Management, IIT Kharagpur

The state-owned banks drowning in bad debt breathed a huge sigh of relief when he Reserve Bank of India (RBI) offered some respite to them by knocking off around 20 companies, including Jaiprakash Associates, from the RBI list of overleveraged companies, which have sold assets and reduced their debt. As a result, lenders will have to put aside less cash to cover their bad debt. The March quarter numbers might look slightly better than the last one, when the PSU Banks posted huge losses.

But the RBI’s generosity is more of a bandage than a cure for the afflictions of the country’s banking system. Estimates of bad loans run into lakhs of crore rupees. Some, but not all, resulted from collusion and graft between borrower and lender. Some loans turned bad because projects once thought feasible ran into regulatory hurdles and were stuck for an indefinite period of time. Due to a lack of proper bankruptcy laws in India, which the Government is trying to change, the liquidation and transfer of the assets of these indebted companies are extremely difficult. This will need legislation, and could take time.

Meanwhile, Asset Reconstruction Companies (ARCs) are given the task to clean this mess. They should take over distressed companies from banks at a discount and convert debt to equity. ARCs can try and turn them around, or sell them to prospective buyers or liquidate assets. After the Vijay Mallya episode, many banks have turned risk-averse and might not want to incur regulatory wrath by selling off assets to new promoters at a discount. Having ARCs as intermediaries could offer them some comfort.

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