Nirmala Sitharaman: Sitharaman’s bad bank plan sparks concern loan prices could be inflated

India’s move this week to set up a bad bank to manage one of the world’s largest piles of soured loans could bring unintended consequences.

One that some market participants say they’ll be closely watching is whether it could wind up inflating the price of distressed assets. That could happen if the creation of the bad bank reduces pressure on loan owners to price such debt at discounts attractive enough to draw other buyers, the argument goes.

Budget Banner

There are many details about the bad bank that policy makers haven’t clarified, including its ownership structure, which makes any analysis challenging. But if the firm is owned by lenders including ones that originated soured assets bought at lower prices, that could force those banks to mark down the value of the securities they receive in exchange. Banking secretary Debasish Panda told reporters this week that banks might have to put in initial capital to start the bad bank.

While the plan provides a new path to resolve soured loans, key issues including the capitalization of the bank, its ownership structure, and the limited secondary market for stressed assets still need to be addressed, said Nitesh Jain, a director at CRISIL Ratings, the local arm of S&P Global Ratings.

Any such issues with the transparency of bad loan pricing could crimp interest in Indian distressed credit that’s been growing in recent years and drawing investors from Oaktree to Apollo.

There would, of course, also be benefits to the bad bank plan announced in the federal budget Monday.

Aggregating soured assets into a single firm could help expedite India’s often protracted debt recasts, and make it easier for foreign funds to build up controlling positions in the debt of companies.

That would be an improvement from the current regime, under which investors have to negotiate individually with each lender, resulting in debt resolutions that take over a year, said Ravi Kumar Bansal, CEO of Edelweiss Asset Reconstruction company, an investor in distressed credit.

But even under the bad bank plan, the need to find a buyer for the distressed loans would still remain, Bansal said.