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By Nupur Anand and Aftab Ahmed
MUMBAI/ NEW DELHI (Reuters) - India's plan to set up a bad bank may boost valuations and ease short-term stress for state-owned lenders, but bankers and sector insiders are concerned it will not solve deeper problems.
Finance Minister Nirmala Sitharaman has proposed creating an asset reconstruction company (ARC) for India's bad-debt laden lenders to offload soured assets, which some analysts estimate now total $100 billion.
"It is a good move but there are more fundamental issues on how to recognise problem loans early and resolve them, which still need to be fixed," Sanjoy Datta, Deloitte India financial services practice head, said of the budget proposal.
Indian banks had gross non-performing assets of 7.5% at the end of September, which the Reserve Bank of India warned could nearly double to 14.8% under a severe stress scenario. State-owned banks account for 9.7%, compared to private ones at 4.6%.
Against this background, Sitharaman is attempting to revive a pandemic-hit economy with limited resources and the bad bank move will ease some of her burden by freeing up balance sheets to boost credit growth, which has hovered around 6% this year.
It would also enable the government to fork out less for stimulus and put a greater onus on banks to lend and pull the economy out of an expected 7.7% contraction this fiscal year.
"Banks are flush with funds, but lending can only happen when there is economic growth," V.G. Kannan, former head of the Indian Banks' Association said.
The government is looking at setting up an ARC that will take over stressed loans from banks and sell these assets to alternative investment funds and other investors.
In doing so it must learn from more than three decades of global experience of bad banks, said Vinayak Bahuguna, former chief executive of asset reconstruction company ARCIL.
"While the bad bank was a success in Spain, it has been a mixed bag in Asia, with the performance not so encouraging in China and Malaysia," Bahuguna said.
"Wherever banks have tried to hold on to the bad assets for long and have lost value due to the delayed sale the experience has been poor," Bahuguna added.
The Indian finance ministry and central bank did not immediately respond to emails, sent outside office hours, seeking comment on concerns over the bad bank.
New Delhi intends to privatise two state-owned banks and sell its stake in private lender IDBI to help refill India's depleted coffers. Analysts said that in the short-term an ARC could achieve its immediate goal of boosting valuations.
The Nifty PSU Bank index, which tracks state-run lenders jumped 7.1%, after Sitharaman announced the ARC proposal and the government outlined plans to privatise two state-owned banks in addition to IDBI Bank.
But concerns remain that a government-backed bad bank may do little to recognise deep-seated asset quality problems.
"State-owned banks that are struggling will be able to attract capital only when their balance sheet is cleaned," said Avneesh Sukhija, an analyst at BNP Paribas.
"The creation of the bad bank will make them attractive to institutional investors. (A) bad bank is a short term solution and not a long term fix." Sukhija added.
Measures introduced by the government and central bank to address toxic loans have not proved effective, bankers said.
"Bad bank is a good idea but the key will be in execution. There are so many problems now with the earlier mechanisms so we clearly need more than just new measures," a senior official at a state-owned bank said.
Another banker said that further steps required to tackle the problem included better price discovery for stressed assets, incentivising the sale of these assets and easing the rules for distressed debt funds in India.
A Bank for International Settlements (BIS) analysis of 135 banks across 15 countries, published in a report a year ago, suggests that recapitalising the lenders will also be key.
The segregation of bad loans is only effective in the clean-up and recovery process when undertaken along with recapitalisation, the BIS report said.
(Reporting by Nupur Anand and Aftab Ahmed; Editing by Alexander Smith)