Raghuram Rajan urges clean-up of bad debts

By Aby Jose Koilparambil and Kanika Sikka

BENGALURU, India (Reuters) - Bad debt held by India's banks must be cleaned up if the country is to achieve stronger economic growth, Reserve Bank of India Governor Raghuram Rajan said on Wednesday, in his second major speech since announcing he will step down in September.

In a speech, he defended actions taken by the RBI, including ordering state-run banks to conduct comprehensive asset quality reviews by March 2017, well after Rajan plans to step down to return to academia.

"The cleaning up of bank balance sheets, and the restoration of credit growth are vital, related elements in the growth agenda," he said. "I know the process is working, so public sector banks will soon be set to finance the enormous needs of this economy once again."

Urging state-run banks and companies to continue dealing with the problem responsibly, he also repeated a call for the government to provide fresh capital for the banking sector.

Rajan's surprise decision to bow out in September, announced in a letter to staff on Saturday, has raised questions about the planned clean-up of $120 billion in soured loans held by Indian banks, a key initiative of his three-year term as governor.

The asset quality review forced banks to recognise $35 billion in new bad loans between September and March, hitting profits and denting credit growth, and Rajan said it was important the process continue.

"To the question of what comes first, clean up or growth, I think the answer is unambiguously "Clean up!," Rajan said in the speech to industrialists in the southern city of Bengaluru.

He rejected an idea proposed by a research body of the Finance Ministry to recapitalise state-run banks by using RBI's own cash surplus, saying that would get regulators "into the business of owning banks, with attendant conflicts of interest."

The speech comes after Rajan on Monday hit back at critics and defended his record in fighting inflation and driving policy reform at a public appearance in Mumbai.

(Writing by Suvashree Dey Choudhury; Editing by Rafael Nam and Catherine Evans)