India to set up bad bank for record levels of soured debt

India will set up a company to manage banks' bad loans, which are expected to reach record levels this year and threaten the financial stability of the world's second-most populous nation.

The firm will hold stressed assets - bad loans, restructured debt and advances to companies that can't service their debt - which can be sold on to investors at a reduced price, Finance Minister Nirmala Sitharaman said in a budget speech on Monday, without giving further details. An index of bank shares surged the most since May, reports Bloomberg.

Like their global peers, Indian lenders are struggling with the economic fallout of the coronavirus, which has triggered an unprecedented economic slump and hurt borrowers' ability to repay debts. Banks were already weakened by a two-year-old shadow lending crisis and are now struggling with one of the worst bad-loan ratios among major nations.

The Reserve Bank of India expects non-performing assets will rise to 13.5% of total advances by the end of September from 7.5% a year ago, according to its semiannual Financial Stability Report published last month. If the number holds through the fiscal year ending March 2022, it would be the worst since 1999.

"The government wants bankers to now boost lending and spin off stressed loans to experts who can focus on recovery," said Karthik Srinivasan, group head of the financial sector at ICRA Ltd., the local arm of Moody's Investors Service Ltd.

"However, a bad bank is not a magic wand that will resolve the issues of India's bad loans in the next few quarters. A lot depends on the fine print of execution plan for the bad bank."

Shares of Indian lenders surged, with the Bankex index climbing as much as 7.4% after the announcement.

The idea of a bad bank has been floated -- and rejected -- for many years. Former chief economic adviser Arvind Subramanian in 2017 recommended setting a bad bank. Former RBI Governor Raghuram Rajan rejected the idea.

Separately, the government plans to pump 200 billion rupees ($2.7 billion) into state-run lenders from April 1, to boost lending in a nation that's set for its worst contraction since at least 1952, Sitharaman said.

The measures follow a 200 billion rupee budgeted infusion in the year ending March 31, but fall short of estimates from ICRA, which expected 430 billion rupees.

While private banks raised about 700 billion rupees in equity capital last year, state-run peers have mainly relied on capital bonds and private placements. As a result, many government-owned banks have cut lending after bad loans spiked and capital waned. Overall lending has slowed to 3.2% this financial year after dropping to a multi-decade low of 6.1% in the year ending March 2020.

Sitharaman also outlined plans to privatize two more state lenders and a state-run insurance firm, in addition to IDBI Bank.

After completing a mega-merger in 2019 that reduced the number of large state banks to 12 from 27, the government has been looking to reduce its stake in some lenders to raise much-needed cash.

The government will also start the sale of a stake in