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Subject: Economics

  • The formidable challenge of reversing a liquidity glut

    The article highlights the challenge in dealing with the excess liquidity in the economy after the central banks injected liquidity by persuing unorthodox policies.

    Overview of policies adopted during 2008 financial crisis

    • Days after the crash of Lehman Brothers, the United States Congress approved an emergency bailout package of $700 billion in September 2008.
    • The amount was used to buy off mortgage-backed securities from banks, hedge funds and pension funds to avert further Lehman-type bankruptcies.
    • As a result, fresh money was injected into the banking system for it to resume normal credit operations and clean up balance sheets.
    • Subsequent actions of the US government and Federal Reserve blurred the distinction between fiscal and monetary policy.
    • ‘Quantitative easing’  was a term coined to describe unorthodox measures like a central bank buying off mortgages and loans, and thus taking credit risk onto its balance sheet.
    • So, quantitative easing was pursued by all the major central banks of the developed world.
    • Central banks embarked upon an aggressive money-printing spree. Assets on their books ballooned.

    Monetary response during pandemic subsequent liquidity glut

    • During the pandemic year more than a decade after the 2008 crisis, the West’s monetary spigots have been opened even more.
    • A liquidity glut has ensued.
    • While the rate of monetary expansion over this period has been healthy, neither employment nor economic output grew by even a fraction of that rate.
    • Central bank finds itself in the maze.

    RBI in a similar situation

    • The Reserve Bank of India (RBI) too finds itself in a similar predicament, where the way out of its liquidity glut is hazy.
    • Due to purchases of foreign exchange externally and of government bonds domestically, RBI’s balance sheet has ballooned by more 30% by August last year.
    • RBI has injected liquidity through long-term repo operations, which essentially provide long-term money at low overnight rates.
    • The Indian central bank has also provided implicit liquidity support to mutual funds.
    • However, the RBI has not quite ventured into taking credit risk onto its books, nor has it signalled a readiness to buy toxic assets.

    Liquidity glut and challenges associated with it

    • As a result of India’s liquidity glut, money is flowing in and out of the central bank to the tune of ₹7 trillion on a daily basis.
    • This has resulted in an anomaly: market lending rates have gone below RBI’s reverse repo rate, which is supposed to be the de facto floor.
    • Cheap money encourages to do foolish and risky things, which, if done widely and voluminously enough, can spell disaster for financial stability.
    • But, any hint of reducing the rate of money expansion threatens to cause panic and burst the bubble it blew.
    • So, when RBI tentatively tried to move market rates higher by announcing a reverse repo auction,the market reaction was one of panic all the same, and there was a spike in interest rates.
    • This caused the central bank to rethink its strategy.
    • To calm nervous bond traders, the governor has categorically said that liquidity support will continue as long as necessary.

    Way forward

    •  We need to plan an exit from the current glut.
    • One way out could be loan ₹5 trillion to the central government against shares of public sector undertakings, at a low rate of 3% for a period of five years to fund its huge deficit.
    • That will bypass markets and not cause any disruption to interest rates.

    Consider the question “Why the challenges posed by liquidity glut caused by the unorthodox policies adopted by the central bank in the aftermath of the pandemic? What are the challenges in reducing the liquidity?” 

    Conclusion

    Whatever the way out of this whirlpool of liquidity, it’s not going to be easy.

  • Agriculture credit

    India’s agriculture credit increased by 500% in the last decade, however, this increase in the credit has not been reflected in the condition of the farmers. The article deals with the issues with the agri-credit in India.

    Impact of credit on agriculture

    • Providing credit to small farmers at a reasonable rate has been the agenda of the Centre, the States, and the Reserve Bank of India (RBI) for decades.
    • However, the volume of credit has improved over the decades, its quality and impact on agriculture have only deteriorated.
    • In 2011-12, the target was ₹4.75-lakh crore; now, agri-credit has reached the target of ₹15-lakh crore in 2020-21 with an allocated subsidy of ₹21,175 crores.
    • Agricultural credit has become less efficient in delivering agricultural growth.

    Issues with agri-credit: small farmers left-out

    • In the last 10 years, agriculture credit increased by 500% but has not reached even 20% of the 12.56 crore small and marginal farmers.
    •  95% of tractors and other agri-implements sold in the country are being financed by non-banking financial companies, or NBFCs, at an 18% rate of interest.
    • The RBI has also questioned agricultural households with up to two hectares getting only about 15% of the subsidized outstanding loan from institutional sources (bank, co-operative society).
    •  As per the Agriculture Census, 2015-16, the total number of small and marginal farmers’ households in the country stood at 12.56 crore which makes up 86.1% of the total holdings.
    • As in the Situation Assessment Survey of Agricultural Households by the National Sample Survey Office (NSSO), the share of institutional loans rises with an increase in land possessed.
    • This shows that the bulk of subsidized agri-credit is grabbed by big farmers and agri-business companies.

    What are the reasons

    • A loose definition of agri-credit has led to the leakage of loans at subsidized rates to large companies in agri-business.
    • The RBI had set a cap that out of a bank’s overall adjusted net bank credit, 18% must go to the agriculture sector, and within this, 8% must go to small and marginal farmers and 4.5% for indirect loans, bank advances routinely breach the limit.
    • A review by the RBI’s internal working group in 2019 found that in some States, credit disbursal to the farm sector was higher than their agriculture gross domestic product (GDP) and the ratio of crop loans disbursed to input requirement was very unevenly distributed.
    •  This shows the diversion of credit for non-agriculture purposes.
    • One reason for this diversion is that subsidized credit disbursed at a 4%-7% rate of interest is being refinanced to small farmers, and in the open market at a rate of interest of up to 36%.

    Way forward

    • The way forward is to empower small and marginal farmers by ‘giving them direct income support on a per hectare basis rather than hugely subsidizing credit.
    • Streamlining the agri-credit system to facilitate higher crop loans to farmer producer organizations, or the FPOs of small farmers against commodity stocks can be a win-win model to spur agriculture growth’.
    • With mobile phone penetration among agricultural households in India being as high as 89.1%, efforts to improve institutional credit delivery through technology-driven solutions can reduce the extent of the financial exclusion of agricultural households
    • There is a need to reforming the land leasing framework and creating a national-level agency to build consensus among States and the Centre concerning agriculture credit reforms.

    Consider the question “Growth in the agriculture sector in India has not been commensurate with the growth in the agriculture credit. What are the reasons for this disparity? Suggest the measures to deal with the challenges in agri-credit delivery.”

    Conclusion

    Improving the access to credit at a reasonable rate will help in increasing their income but to do that reforms in credit delivery is the need of the hour.

  • What is The Great Reset?

    This news card is an excerpt from the original article published in The Indian Express and is articulated by C. Raja Mohan.

    The Great Reset

    • The Great Reset is a proposal by the World Economic Forum (WEF) to rebuild the economy sustainably following the COVID-19 pandemic.
    • It was unveiled in May 2020 by the United Kingdom’s Prince Charles and WEF director Klaus Schwab.

    The basis for the said reset

    • It is based on the assessment that the world economy is in deep trouble.
    • Schwab has argued that the situation has been made a lot worse by many factors, including the pandemic’s devastating effects on global society, the un- folding technological revolution, and the consequences of climate change.
    • He demands that the world must act jointly and swiftly to revamp all aspects of our societies and economies, from education to social contracts and working conditions.
    • Every country must participate, and every industry, from oil and gas to tech, must be transformed.

    Agenda behind

    The agenda of The Great Reset touches on many key issues facing the world a/c to C Raja Mohan. Three of them stand out as:

    First is the question of reforming capitalism

    • The WEF has been at the forefront of calling for “stakeholder capitalism” that looks beyond the traditional corporate focus on maximizing profit for shareholders.

    Second, it is certainly right to focus on the deepening climate crisis

    • Climate skeptics have been ousted from Washington and President Biden has rejoined the 2015 Paris accord on mitigating climate change.

    The third is the growing difficulty of global cooperation

    • The era of great power harmony that accompanied the liberalization of the global economy at the turn of the 1990s has yielded place to intense contestation. The contestation is not just political but increasingly economic and technological.

  • The Cost of Guaranteed MSP

    The row over legally guaranteed MSP doesn’t seem to be settled down in near terms.

    Farmers’ demand

    • Farmer unions protesting are raising two fundamental demands.
    1. The first is for repealing the three agricultural reform laws enacted by the Centre.
    2. The second is to provide a legal guarantee for the minimum support prices (MSPs) that the Centre declares for various crops every year.
    • Currently, there is no statutory backing for these prices or any law mandating their implementation.

    Note: The MSP is now applicable on 23 farm commodities: 7 cereals (paddy, wheat, maize, bajra, jowar, ragi and barley), 5 pulses (chana, arhar, moong, urad and masur), 7 oilseeds (groundnut, soyabean, rapeseed-mustard, sesamum, sunflower, nigerseed and safflower) and 4 commercial crops (sugarcane, cotton, copra and raw jute).

    Can MSP be made legally binding?

    Yes. There are two ways it can be done.

    (1) To force private buyers to pay it

    • In this case, no crop can be purchased below the MSP, which would also act as the floor price for bidding in mandi auctions.
    • There’s already a precedent: In sugarcane, mills are required by law to pay growers the Centre’s “fair and remunerative price” – UP and Haryana fix even higher “state advised prices” – within 14 days of supply.
    • In no other crop is the compulsion to pay the government-announced MSP thrust on the private trade/industry.

    (2) The government itself buying the entire crop that farmers offer at the MSP

    Various govt agencies such as the Food Corporation of India, the National Agricultural Cooperative Marketing Federation of India, and the Cotton Corporation of India (CCI) do procure a large chunk of commodities on MSP.

    But how much produce can the government procure at MSP?

    • The MSP value of the total production of the 23 crops worked out to around Rs 10.78 lakh crore in 2019-20.
    • Not all this produce, however, is marketed. Farmers retain part of it for self-consumption, the seed for the next season’s sowing, and also for feeding their animals.
    • The marketed surplus ratio for different crops is estimated to range differently for various crops.
    • It ranges from below 50% for ragi and 65-70% for bajra (pearl millet) and jawar (sorghum) to 75% for wheat, 80% for paddy, 85% for sugarcane, 90% for most pulses, and 95%-plus for cotton, soyabean etc.
    • Taking an average of 75% would yield a number of just over Rs 8 lakh crore.
    • This is the MSP value of production that is the marketable surplus — which farmers actually sell.

    So, is this MSP money paid out of the government’s pocket?

    Not really!

    • To start with, one must exclude sugarcane from the calculations. The onus for paying cane MSP, as earlier pointed out, lies on sugar mills and not the government.
    • Secondly, the government is already procuring many crops – especially paddy, wheat, cotton, and also pulses and oilseeds.
    • Thirdly, government agencies don’t have to buy every single grain that comes to the market. Mopping up even a quarter or third of the market arrivals is usually enough to lift prices.
    • Fourth, the crop bought on government account also gets sold. While such sales in wheat and paddy – which are distributed at super-subsidized rates under the National Food Security Act.
    • This entails heavy losses, but those are far less in the remaining MSP crops. The revenues realized from sales would partly offset the expenditures from MSP procurement.

    All in all, the additional fiscal outgo, from the government undertaking the maximum required procurement for guaranteeing MSP to farmers, may not be more than Rs 1-1.5 lakh crore per year.

    So, is the MSP system all okay?

    Nope!

    • The government undertaking to buy at MSP is definitely better than forcing private players. Their going out of business would ultimately hurt farmers most.
    • However, even assured government MSP-based procurement is fraught with problems.
    • The coverage of MSPs today does not extend to fruits, vegetables, and livestock products that together have a 45% share in the gross value of the output of India’s agriculture, forestry, and fishing sector.
    • The value of milk and milk products alone is more than that of all cereals and pulses combined.

    Limitations for govt.

    • Extending MSP to all farm produce and guaranteeing it through law is hugely challenging, fiscally and otherwise.
    • It also explains why economists increasingly are in favor of guaranteeing minimum “incomes” rather than “prices” to farmers.
    • One way to achieve that is via direct cash transfers either on a flat per-acre (as in the Telangana government’s Rythu Bandhu scheme) or per-farm household (the Centre’s PM Kisan Samman Nidhi) basis.

    Back2Basics:

    (1) Rythu Bandhu Scheme

    • Under Rythu Bandhu, the Telangana government gives every beneficiary farmer Rs 4,000 per acre as “investment support” before every crop season.
    • The objective is to help the farmer meet a major part of his expenses on seed, fertilizer, pesticide, and field preparation.
    • The scheme covers 1.42 crore acres in the 31 districts of the state, and every farmer owning land is eligible.

    (2) Pradhan Mantri Kisan Samman Nidhi

    • Under this program, vulnerable landholding farmer families, having cultivable land up to 2 hectares, will be provided direct income support at the rate of Rs. 6,000 per year.
    • This income support will be transferred directly into the bank accounts of beneficiary farmers, in three equal installments of Rs. 2,000 each.
    • Around 12 crore small and marginal farmer families are expected to benefit from this.

  • Tighter regulatory framework for NBFCs

    The Reserve Bank of India (RBI) has suggested a tougher regulatory framework for the non-banking finance companies’ (NBFC) sector to prevent the recurrence of any systemic risk to the country’s financial system.

    Try this PYQ:

    Which of the following can be said to be essentially the parts of Inclusive Governance?

    1. Permitting the Non-Banking Financial Companies to do banking
    2. Establishing effective District Planning Committees in all the districts
    3. Increasing government spending on public health
    4. Strengthening the Mid-day Meal Scheme

    Select the correct answer using the codes given below:

    (a) 1 and 2 only

    (b) 3 and 4 only

    (c) 2, 3 and 4 only

    (d) 1, 2, 3 and 4

    What are NBFCs?

    • Nonbank financial companies (NBFCs) are financial institutions that offer various banking services but do not have a banking license.
    • An NBFC in India is a company registered under the Companies Act, 1956 engaged in the business of loans and advances, acquisition of shares/stocks/bonds/debentures/securities issued by a government or local authority, or other marketable securities.
    • A non-banking institution that is a company and has principal business of receiving deposits under any scheme or arrangement in one lump sum or in installments is also an NBFC.

    What is the difference between banks & NBFCs?

    NBFCs lend and make investments and hence their activities are akin to that of banks; however, there are a few differences as given below:

    • NBFC cannot accept demand deposits
    • NBFCs do not form part of the payment and settlement system and cannot issue cheques drawn on itself
    • The deposit insurance facility of Deposit Insurance and Credit Guarantee Corporation is not available to depositors of NBFCs, unlike in the case of banks

    What are the new RBI regulations?

    • The regulatory and supervisory framework of NBFCs will be based on a four-layered structure — the base layer (NBFC-BL), middle layer (NBFC-ML), the upper layer (NBFC-UL), and the top layer.
    • If the framework is visualized as a pyramid, at the bottom of the pyramid will be those where least regulatory intervention is warranted.
    • It can consist of NBFCs currently classified as non-systemically important NBFCs.
    • Moving up, the next layer may comprise NBFCs currently classified as systemically important NBFCs (NBFC-ND-SI), deposit-taking NBFCs (NBFC-D), HFCs, IFCs, IDFs, SPDs, and CICs.
    • The regulatory regime for this layer shall be stricter compared to the base layer.
    • The next layer may consist of NBFCs identified as ‘systemically significant’.
    • This layer will be populated by NBFCs having a large potential of systemic spill-over of risks and the ability to impact financial stability.

  • Getting it wrong on India’s level of agricultural support

    As per the OECD methodology, Indian farmers received negative support of Rs. 1.62-lakh crore in 2019, which implies that the government is taxing the farmers. But there are pitfalls in the methodology. The article explaines them.

    The issue of support given to the farmers

    • Many media reports, based on data by the Organisation for Economic Co-operation and Development (OECD), have stated that the support provided to Indian agriculture is extremely low or negative, and, therefore, net taxed.
    • The OECD has estimated that Indian farmers received negative support to the extent of minus ₹2.36-lakh crore and minus ₹1.62-lakh crore in 2010 and 2019, respectively.
    • Surprisingly, the negative support of minus ₹1.62-lakh crore as estimated by the OECD was higher than the total budgetary allocation of the Ministry of Agriculture at ₹1.09-lakh crore in 2019.

    Issues with the OECD estimates

    • Expenditure on the PM-KISAN, the National Food Security Mission, crop insurance, input subsidies such as fertilizer and electricity, are some of the measures covered under the 2019 OECD estimates.
    • However, the expenditure related to the operation of minimum support price and general services is not covered by it.
    • Despite the overall negative support, the expenditure of the Central and State governments on agriculture has increased substantially since 2000.
    • This support increased from ₹1.61-lakh crore to ₹3-lakh crore, between 2015 to 2019, registering 85% growth.
    • The massive negative market price support to the producers of different products has resulted in the total negative producer support, overshadowing the increase in the budgetary support over the years.

    Market Price Support as per OECD methodology

    • The market price support of a commodity is calculated by multiplying its total production with the gap between the domestic price and international prices in a relevant year.
    • This methodology assumes that in case there is no government intervention in the agriculture market, then the domestic and international price of a product will converge, resulting in no gap in prices.

    Why there is a focus on the price gap in OECD methodology

    • The OECD assumes government interventions lead to a gap between the international and domestic prices.
    • However, even if the government does not implement any program, the gap can still arise due to domestic and international factors.
    • Changes in supply and demand conditions in the domestic and international market due to shocks, depressed international prices due to subsidies given by other countries, among other factors, can generate a gap.

    3 Consequence of OECD’s Market Price Support methodology

    • 1) If the domestic price for a product is less than its international price, then support for that product would be negative.
    • 2) A negative market price support for a product in one year can turn into huge positive support in another year on account of the relative movement of domestic and international prices.
    • 3) Even if in a particular year, the government does not provide any additional support compared to a previous year, the level of support calculated by the OECD can change.
    • This will arise if there is a change in either the gap between the domestic price and international price for a commodity, or its production, in the two years.
    • Given the unpredictability in the inherent data, the total support can move from huge negative to huge positive.

    Concerns for India

    • For India, the negative support as a percentage of the total value of agriculture production has substantially reduced in recent years.
    • It is possible that support to Indian farmers in the near future becomes one of the highest in the world due to pitfalls in the OECD methodology.
    • This might set alarm bells ringing, particularly in the developed countries, which may aggressively question India’s support measures.

    Consider the question “As per the OECD methodology, net support provided by Indian government to its farmers is negative for the year 2019. However, India’s expenditure on agriculture is consistently rising. What explains this conundrum? What are the concerns for India in the price support method of OECD?”

    Conclusion

    Rather than being swayed by the OECD numbers suggesting negative support, farmers, policymakers, and other stakeholders need to understand the pitfalls and limitations in the underlying methodology. This will help in providing a more correct perception of the level of support to agriculture in India.

  • Digital Service Tax could be an interim solution to cyber tax conundrum

    Business models of digital companies challenge the conventional basis of taxation in which the fixed place of business formed the basis. Digital Service Tax could provide a basis to deal with the challenge. The article deals with this issue.

    Equalisation levy and issues with it

    • Equalisation levy seeks to tax payments made for online advertising services to a non-resident business by residents in India.
    • India is amongst the first to have implemented such levy.
    • It is predominantly applicable to US companies since the market for digital services is dominated by US-based firms.
    • Any company that has a permanent residence in India is excluded since it is already subject to tax in India.
    •  In March 2020, India expanded the scope of the existing equalisation levy to a range of digital services that includes e-commerce platforms.
    • Such levy can result in over-taxation since the company will not be able to claim any credit for tax paid on Indian sales.
    • Such an approach is often viewed as contrary to the ethos of international agreements.

    Issue of taxation of digital companies

    • The agenda to reform international tax law so that digital companies are taxed where economic activities are carried out was formally framed within the OECD’s base erosion and profit shifting programme.
    • Worried they might cede their right to tax incomes, many countries have either proposed or implemented a digital services tax (DST).
    • However, the proliferation of digital service taxes (DSTs) is a symptom of the changing international economic order.
    • Countries such as India which provide large markets for digital corporations seek a greater right to tax incomes.
    • The core problem that the international tax reform seeks to address is that digital corporations, unlike their brick-and-mortar counterparts, can operate in a market without a physical presence.
    • The current basis for taxing in a particular jurisdiction is a notion of fixed place of business.

    Way forward

    • To overcome the challenge, countries suggested that a new basis to tax, say, the number of users in a country.
    • The EU and India were among the advocates of this approach.
    • In 2018, India introduced the test for significant economic presence in the Income Tax Act.
    • However, the proposal of a revised nexus was not supported widely.
    • Moreover, to give effect to a new system would require bilateral renegotiation of tax treaties that supersede domestic tax laws.
    • Meanwhile, the OECD continued to work to find commonalities among a range of solutions.
    • In its current form, the solution is too complex to administer and proposes to allocate residual profit — a term that has no economic definition.
    • It would also require political consensus on multiple issues, including sensitive matters such as setting up of an alternative dispute resolution process comparable to arbitration.
    • This can increase the compliance burden.
    • The US has expressed its preference to apply this measure on a safe harbour basis, which can limit the companies to which it may be applicable.

    Consider the question “Digital corporations can operate in a market without a physical presence. The current basis for taxing in a particular jurisdiction is a notion of fixed place of business. In light of this, examine the challenges in taxing the digital companies and how India is dealing with such a challenge?” 

    Conclusion

    As countries calibrate their response to competing demands for sovereignty to tax, DST is an interim alternative outside tax treaties. It possesses the advantage of taxing incomes that currently escape tax and creates space to negotiate a final, overarching solution to this conundrum.

  • What is Section 32A of IBC?

    The Supreme Court has held that the bidders for a corporate debtor under the Insolvency and Bankruptcy Code (IBC) would be immune from any investigations being conducted either by any investigating agencies.

    Q.Examine the impact of various amendments to the Insolvency and Bankruptcy Code (IBC) and suggest further improvements in the IBC.

    Backgrounder: IBC

    • IBC was enacted on May 28, 2016, to effectively deal with insolvency and bankruptcy of corporate persons, partnership firms and individuals, in a time-bound manner.
    • It has brought about a paradigm shift in laws aimed to maximize the value of assets, providing a robust insolvency resolution framework and differentiating between impropriety and business debacle.
    • The predominant object of the Code is the resolution of the Corporate Debtor.
    • It has been amended four times to resolve problems hindering the objectives of the Code.

    What is Section 32A?

    • In cases involving property of a corporate debtor, Section 32A covers any action involving attachment, seizure, retention, or confiscation of the property of the corporate debtor as a result of such Proceedings.
    • It provides immunity to the corporate debtor and its property when there is the approval of the resolution plan resulting in the change of management of control of the corporate debtor.
    • This is subject to the successful resolution applicant being not involved in the commission of the offense.

    What were the challenges?

    • Since the IBC came into being in 2016, the implementation of the resolution plan of several big cases has been delayed because of various challenges mounted by its own agencies and regulators.
    • For example, a debt-laden company, admitted into insolvency in 2017, owes more than Rs 47,000 crore to banks and other financial institutions.
    • After a prolonged bidding battle, another won the rights to take over it with a bid of Rs 19,700 crore.
    • However, before it could move to take over, the ED/SEBI swooped in, and attached assets worth Rs 4,000 crore citing alleged fraud in a bank loan under the Prevention of Money Laundering Act (PMLA).

    Observations made by the SC

    • In its judgment, the apex court upheld the validity of Section 32.
    • It said it was important for the IBC to attract bidders who would offer reasonable and fair value for the corporate debtor to ensure the timely completion of the corporate insolvency resolution process (CIRP).
    • Such bidders, however, must also be granted protection from any misdeeds of the past since they had nothing to do with it.
    • Such protection, the court said, must also extend to the assets of a corporate debtor which will help banks clean up their books of bad loans.
    • The apex court has, however, also said that such immunity would be applicable only if there are an approved resolution plan and a change in the management control of the corporate debtor.

    Significance of SC’s intervention

    • With the Supreme Court upholding the validity of Section 32 A will give confidence to other bidders to proceed with confidence while bidding on such disputed companies and their assets.

    Must read

    [Burning Issue] Insolvency and Bankruptcy Code

  • Secured Overnight Financing Rate (SOFR)

    State Bank of India (SBI) has executed two inter-bank short term money market deals with pricing linked to SOFR (Secured Overnight Financing Rate).

    Try this PYQ:

    Q.The money multiplier in an economy increases with which one of the following?

    (a) Increase in the cash reserve ratio

    (b) Increase in the banking habit of the population

    (c) Increase in the statutory liquidity ratio

    (d) Increase in the population of the country

    What is SOFR?

    • Secured Overnight Financing Rate (SOFR) is a secured interbank overnight interest rate.
    • It is a replacement for USD LIBOR (London Inter-bank Offered Rate) that may be phased out end-2021.
    • The overnight rate is generally the interest rate that large banks use to borrow and lend from one another in the overnight market.

    Why SOFR?

    • Global regulators decided to move away from the Libor, a vital part of the financial system after it was revealed in 2012 that banks around the world manipulated it.
    • It also didn’t help that volume underlying the benchmark dried up.
    • U.K regulators set the deadline at 2021 for financial firms and investors to transition away from the Libor.

  • It’s better to stop the creation of bad debt than set up a bad bank

    The article argues that instead of creating the Bad Bank, several steps taken by the government and the bank regulator could deal with the problem of NPAs and also improve the performance of the banks.

    Challenge of NPA: Is Bad Bank and answer to it?

    • Recently, RBI governor said that the RBI was open to considering setting up of a “bad bank”.
    • India’s economic growth, unless pandemic risks resurface, should be good enough to largely take care of its non-performing assets (NPAs) in the coming years.
    • It was the high economic and credit growth of the 2003-08 period that whittled down the NPA ratio.
    • The provision coverage ratio at banks had gone up from 42% in 2016 to 72.4% in September 2020, and that net NPAs were down to 2.8% in March 2020.
    • The bad loan legacy is almost done with.
    • Consequently, the bad bank is a right idea at the wrong time.

    Steps the government and RBI should take

    1) Resume the operation of IBC

    • The government should reinstate the operation of the Insolvency and Bankruptcy Code (IBC).
    • The code had improved the recovery rate from NPAs in the banking system.
    •  There is a need to create disincentives for deliberate delaying tactics, so that the original timeline of 270 days is honoured more in its observance than in breach.

    2) Recapitalisation of banks

    • The government should provide more than adequate capital to the strong banks it owns, and adequate capital to the not-so-strong ones, with well-defined performance criteria for them to receive more.
    • If they don’t deliver, then the government should consolidate them or begin diluting its stake below 51% in such banks.

    3) Level playing field improvement in compliance culture

    • The government should level the regulatory playing field between private-sector and government-owned banks.
    • The risk management and compliance culture in public-sector banks must improve.
    • However,  public sector banks should not be subject to excessive oversight by government investigative and audit agencies.

    4) Plug the sources of NPAs through policy changes

    • More than these, there are two other important things that constitute the fountainheads of NPAs.
    • The government should evolve a framework for passing on explicit development goals of the state for banks to achieve through the credit mechanism.
    • The government should provide for them in the budget and compensate banks rather than direct credit by diktat.
    • The cost of directed lending is not just the creation of NPAs, but morale and market-value erosion as well.
    • In any case, recapitalization needs mean that the fiscal costs are not avoided. It is self-defeating.
    • Then, governments (Union and states) should plug the other underlying sources of NPAs.
    • Among things, they should ensure economic pricing of utilities, honour power purchase contracts and raw material purchase agreements, pay arrears to private counterparties, and stop being reflexive litigants.

    Consider the question ” What is the Bad Bank? Do you agree with the view that India needs Bad Bank?”

    Conclusion

    The above measures would greatly help the country achieve high growth and sustain it. Setting up a bad bank may be unnecessary.

    Back2Basics: Provisioning Coverage Ratio (PCR)

    • Banks usually set aside a portion of their profits as a provision against bad loans.
    • Provisioning Coverage Ratio (PCR) is essentially the ratio of provisioning to gross non-performing assets (NPA) and indicates the extent of funds a bank has kept aside to cover loan losses.
    • A high PCR ratio (ideally above 70%) means most asset quality issues have been taken care of and the bank is not vulnerable.