Which of the following best explains the “Twin Balance Sheet” problem in the Indian economy?
(A) High fiscal deficit and current account deficit
(B) High NPAs and low capital buffer in NBFCs
(C) Stressed balance sheets of banks and over-leveraged corporates
(D) Bad loans in agriculture and MSME sector
The correct answer is (C) Stressed balance sheets of banks and over-leveraged corporates.
Explanation ⛓️
To fully understand this, let’s define the key terms first.
- Balance Sheet: A financial statement showing a company’s assets (what it owns) and liabilities (what it owes) at a specific time. A “stressed” balance sheet means liabilities are dangerously high compared to assets or the income needed to service the debt.
- Twin Balance Sheet (TBS) Problem: This term, popularized by India’s Economic Survey, describes a specific crisis where the balance sheets of two critical sectors of the economy—the corporate sector and the banking sector—are under severe stress simultaneously.
The problem unfolds in two parts:
- Over-leveraged Corporates: The first balance sheet is that of large corporations. A company is “over-leveraged” when it has taken on too much debt relative to its earnings. During India’s economic boom in the mid-2000s, many companies borrowed heavily to invest in large infrastructure projects. When growth slowed, their profits fell, and they found it difficult to repay these loans.
- Stressed Banks & NPAs: The second balance sheet is that of the banks. When corporates fail to repay their loans, these loans become Non-Performing Assets (NPAs) for the banks. An NPA is a loan for which interest or principal payments have been overdue for 90 days. High NPAs weaken a bank’s financial health, reduce its profitability, and erode its capital.
This creates a vicious cycle: Stressed companies can’t pay back loans, which makes banks stressed. Stressed banks become reluctant to give new loans, which chokes off investment and prevents companies from growing, making it even harder for them to repay their old debt. This combined weakness severely hampers the entire economy.
Analysis of Other Options
- (A) High fiscal deficit and current account deficit:
- A Fiscal Deficit is the shortfall in a government’s revenue compared to its total expenditure.
- A Current Account Deficit (CAD) occurs when a country’s total value of imports of goods and services is greater than the total value of its exports.
- Together, these are known as the “Twin Deficit Problem,” a separate macroeconomic issue, not the Twin Balance Sheet problem.
- (B) High NPAs and low capital buffer in NBFCs:
- NBFCs (Non-Banking Financial Companies) are institutions like Bajaj Finance or Muthoot Finance that provide financial services but do not have a full banking license.
- While high NPAs in the NBFC sector are a major concern, the classic “Twin Balance Sheet” problem specifically refers to the stress in commercial banks caused by the corporate sector.
- (D) Bad loans in agriculture and MSME sector:
- MSME stands for Micro, Small, and Medium Enterprises.
- While bad loans from these sectors are a part of the overall NPA problem, the term “Twin Balance Sheet” was coined to describe the massive stress originating from large corporations, especially in sectors like infrastructure, steel, and power. Therefore, this option is too narrow.