India’s slow-moving banking crisis continues to drag on, as ponderous and unstoppable as the state-controlled banking sector itself. A recent study found that the gross “non-performing assets” of state banks rose 56 percent in 2016, and 135 percent in the last two years. They now account for 11 percent of all state bank loans.

These are hardly reassuring numbers. Yet the government -- which, after all, owns these banks and thus dominates the Indian financial sector -- appears relatively unconcerned. In the most recent budget, the government set aside barely $1.5 billion to recapitalize the banks.

Who has time for a slow-moving crisis in India, a country where life comes at you fast? Instead of being allowed to focus on bad loans, the state-controlled banking sector has been buffeted by one task after another dealt out by its principal owner. Banks have spent months dealing with the fallout of Prime Minister Narendra Modi’s decision to withdraw 86 percent of India’s currency. There still aren’t enough currency notes in ATMs, as a senior Finance Ministry official admitted recently. And though forced deposits mean banks’ cash resources have increased, nobody knows for sure how much of that money will remain in bank accounts once withdrawal limits are lifted.

Meanwhile, the state bank sector has become the government’s primary tool for many of its other plans. Banks are supposed to be the primary conduit for drawing tens of millions of poor Indians into the financial system, for example. They’re being told to solve India’s jobs crisis as well: Officials insist that a government scheme to provide easy loans to small entrepreneurs will help employment recover. So who has time to fix bad loans? The Reserve Bank of India asked banks to conduct an “asset quality review” a few years ago, which was due to end on Wednesday. There are already voices suggesting that the deadline be extended, given the pressures of demonetization.

This lack of attention is puzzling. The bad-loan crisis, together with demonetization, has pretty much wrecked the credit pipeline -- and, consequently, India’s growth prospects. Recently, credit growth hit 5.1 percent, and the chief economist of India’s largest state bank, the State Bank of India, said that represented its lowest point since 1960. Most analysts expect credit growth to range between 5 percent and 6 percent in the coming months, nowhere near the double-digit numbers needed to get an investment recovery going.

Two things need to happen: State-controlled banks need to get these loans resolved; then the system that allowed them to build up needs to be demolished. Each of these has an obvious solution. The problem is that the government is simply unwilling to implement either one.

Resolving loans isn’t a simple process. Somebody ultimately has to take a haircut. That requires a system in which people are able to make decisions based on discernible facts on the ground. Which project will be viable once it’s restructured? Which will require more money? Which should be shut down?

India doesn’t have a system like that yet. At the moment, decision-makers face political pressure to protect sensitive projects. And bank officials worry that any choice they make could come back to haunt them later if some anti-corruption crusader accuses them of taking bribes.

True, India passed a bankruptcy law recently. And that’s a useful achievement. But it’s simply words on paper without institutional backing -- and the institutions aren’t there yet. Unlike in the US, you can’t expect courts to supervise resolution; India has a case-backlog crisis as deadly as (and even slower-moving than) its bad-loan crisis. And although the original draft of the bill called for the government to set up an entire cadre of resolution professionals, that crucial requirement had mysteriously disappeared by the time the bill became law. So, again, who’s going to evaluate these projects and price these bad loans?

Recently, RBI Deputy Gov. Viral Acharya backed the creation of a “bad bank” to take non-performing assets off bank balance sheets. That would certainly help coordination between creditors. But it wouldn’t address the basic problem: figuring out at what price the bad bank should buy these assets. If it’s too high, then you won’t get private-sector participants; if the haircut is too much, careerist bank officials will be unwilling to sell.

And, finally, what will keep state banks from making the same mistakes again? Well, the answer is: If they’re subject to market discipline and not burdened with multiple objectives imposed by their harassed owners in New Delhi.

Bad loans are the result of the government ordering banks to support big, growth-promoting, but risky infrastructure projects during India’s boom years -- and then politically connected companies procuring bridge loans when those projects turned sour. Private-sector banks managed to extricate themselves from such mistakes handily. If state-owned banks didn’t, it’s pretty obvious why. And it’s equally obvious what has to be done: Privatize them. If this government is as bold and courageous as it likes to claim, that should be its first priority.

By Mihir Sharma
Mihir Sharma is a Bloomberg View columnist. --Ed.

(Bloomberg)