India must not neglect bank recap despite pandemic: Viral Acharya

India is neglecting bank recapitalisation as it focuses on debt moratoriums and interest waivers for borrowers amid the pandemic, former RBI Deputy governor Viral Acharya said on Monday.

Indian banks are saddled with over $120 billion in bad debt, and in severely stressed conditions the bad-loan ratio could nearly double by March, according to Reserve Bank of India projections. Restoring banks’ capital is critical for aiding a meaningful recovery, but there has been little focus on the matter, he said. “This lack of focus is tantamount to kicking the can down the road and jettisoning financial stability for short-term gains,” said Acharya, who wrote a book titled the “Quest for Restoring Financial Stability in India”.

“This repeated mistake has prevented India from recovering well from adverse shocks,” Acharya said. His comments came weeks after India offered to waive the compounded interest component on all loans up to ~2 crore following a legal challenge to the terms of a six-month moratorium. Designing moratoria and forgiveness like farm loan waivers that favour borrowers in the short term has been detrimental to a sound recovery of credit growth in the medium term, he said.

Though the latest one-time restructuring package has been fine-tuned to ensure it cannot be misused, it still has a little bit of a “band-aid and short-termism” approach to it, he said.

Funds to provide for the losses that would be incurred through restructuring should be set aside so that banks do not strangle growth as the economy begins to recover after the pandemic.

“If the government doesn’t wish to recapitalise banks in a timely manner, then it must ensure that the contours of debt moratoria and forgiveness package aren't so generous that banks won't be in a position to lend well during the recovery phase, which is likely around the corner,” Acharya said. “It would be good to learn from the past mistakes and start the work of repairing bank balance sheets at the same time as giving a soft landing to bank borrowers and the real economy.”