Bengaluru (Karnataka): Bad debt held by banks must be cleaned up if the country is to achieve stronger economic growth, Reserve Bank of India (RBI) Governor Raghuram Rajan said on Wednesday, in his second major speech since announcing he will step down in September.

Speaking to industrialists in Bengaluru, he defended actions taken by the RBI, including ordering state-run banks to conduct comprehensive asset quality reviews by March 2017, well after Rajan plans to step down to return to academia.

"What is required to restart it (public sector banking system) is a clean-up of the balance sheets of the public sector banks and this process is underway. The public sector banks have risen to the occasion and have done more than what was expected of them and my belief is when this process is taken to its logical conclusion, they will have sustainable balance sheets to support the growth," said Rajan.

India's banks are struggling under USD 100 billion of stressed loans, choking the financial system at a time when the economy needs fresh investment to galvanize growth.

Urging state-run banks and companies to continue dealing with the problem responsibly, he also repeated a call for the government to provide fresh capital for the banking sector.

Rajan's surprise decision to bow out in September, announced in a letter to staff on Saturday, has raised questions about the planned clean-up of USD 120 billion in soured loans held by Indian banks, a key initiative of his three-year term as governor.

The asset quality review forced banks to recognise USD 35 billion in new bad loans between September and March, hitting profits and denting credit growth, and Rajan said it was important the process continue.

Rajan said that public sector banks were not pro-active in evaluating the viability of a project, a reason for mounting bad loans.

"Unfortunately too many projects were left weakly monitored even as their cost increased. Now some banks may have expected lead bank in the consortium to exercise adequate, due diligence but this did not always happen. Moreover as a project went into distress, private banks were somewhat more agile, sometimes, in securing their positions with additional collateral from the promoter," said Rajan.

He rejected an idea proposed by a research body of the Finance Ministry to recapitalize state-run banks by using RBI's own cash surplus, saying that would get regulators "into the business of owning banks, with attendant conflicts of interest."