The assumption so far was that infusion of funds by the government through re-capitalisation bonds would be enough to clean up bank balance sheets. The scheme seems to have worked for many banks, but Indian Bank has proved to be a glaring exception. This year's budget has mooted the formation of asset reconstruction companies, which would be set up by the weak banks and take over their bad debt portfolio.

The advantage of an asset reconstruction company is that it would have a focussed objective of recovering bad debts. Of course, all banks have recovery cells, but NPA figures can be doctored by giving fresh loans to defaulters and NPA percentages can be dressed up by boosting the level of new advances. The annual accounts of an asset reconstruction company,on the other hand, would show exactly the amount which has been recovered. Further, such companies would also be more eager to strike compromise deals with defaulters, since they would have bought the assets at a discount, and any realisation above the discounted value would mean a profit for them. Apart from the greater focus on recovery, there is one other purpose which transferring bad assets serves -- it cleans up the bank's balance sheet at one go, and enables it to tap the capital markets. That means the government will be spared the necessity of funding re-capitalisation. But this objective of tapping the markets for capital will be possible only if the asset reconstruction companies are not subsidiaries of the banks themselves.

Parent companies are liable for their subsidiaries' health, and the markets would not subscribe to bank paper tainted with the bad assets of the subsidiaries. It also makes eminent sense to pool all the bad assets of the banks' in one asset reconstruction company, rather thandistribute them among a whole lot of bank subsidiaries. Yet, even after today's bad debts are transferred, the problem of new bad debts remains. Indian Bank's bad debts, after all, are of relatively recent vintage. The only way to solve that problem is to ensure that bank managements are called upon to shoulder their responsibility for the bank's actions. Nor should this responsibility be limited to advances, because that merely mean that no loans would be granted. It would make more sense to make managements responsible for bank profitability, with the clear understanding that managements would be changed if they do not perform.