Context: India’s Bad Bank, the National Asset Reconstruction Company Ltd (NARCL) heralded as the panacea for the nation’s burgeoning nonperforming asset (NPA) crisis. However NARCL is grappling with many challenges.
Basics of Bad Bank
- Understanding the concept of a Bad Bank is crucial to evaluating NARCL’s role.
- Bad bank is an entity that consolidates a bank’s bad loans or non-performing assets (NPAs) and works towards resolving or liquidating these stressed assets to recover maximum value.
Difference between Bad Bank and National Asset Reconstruction Company Limited (NARCL)
- Ownership: The Bad Bank, initially proposed by the Economic Survey 2016-17 was to be set up and owned by the Government. However, NARCL has been set up by banks themselves.
- Since the nature of role performed by them is the same, the terms "Bad Bank" and "ARC" can be used interchangeably.
National Asset Reconstruction Company Limited (NARCL)
- Asset Reconstruction Companies are registered with the RBI under the provisions of SARFAESI Act.
- NARCL has been incorporated under the Companies Act and has received a certificate of registration from the RBI to commence the business of an Asset Reconstruction Company.
- NARCL will majorly be owned by Public Sector Banks. Canara bank is the Sponsor with shareholding of up to 12 per cent.
- NARCL would be capitalised through a combination of equity and debt from various Banks and will have a finite life of 5 years.
India Debt Resolution Company Ltd. (IDRCL)
- It has been set up as Asset Management Company (AMC) to deal with NPAs.
- It will have a minimum of 51% ownership of Private sector Banks and balance will be held by Public Sector Banks.
Difference between ARC and AMC
- ARC buys Bad loans from Banks and then transfers them to the AMC.
- The AMC would then carry out restructuring to recover the bad loans.
- The AMC would be manned by professionals who have necessary expertise in recovering the Bad loans.
Relationship between NARCL and IDRCL
- NARCL and IDRCL’s relationship will be defined through a debt management agreement where NARCL will aggregate and acquire the stressed assets and IDRCL will provide stressed assets management and resolution services to NARCL on an exclusive basis.
- The term of IDRCL shall be coterminous with that of NARCL, i.e., 5 years.
How NARCL Deals With Stressed Assets?
- Step 1: The NARCL would buy NPAs from the Banks. The Money is paid to the Banks in the form of Cash and Security Receipts. 15% of money is paid in form of Cash and 85% in form of Security Receipts (SR). The SARFAESI Act provides for the issuance of Security Receipts.
- Step 2: Decrease in NPAs on Banks' Balance Sheets-->Lower Provisioning--> Capital gets unlocked→ Increase in Credit Creation--> Economic growth.
- Step 3: The NARCL-IDRCL recovers the NPA either through Debt restructuring or sale of mortgaged assets.
- Step 4: The NARCL makes the payment for the security receipts after deducting its management fee.
- Role of the Government:
- The Government has decided to give guarantee worth Rs 30,600 crores on the payment of security receipts by the NARCL.
- If the NARCL is unable to sell the bad loan, or sold it at a loss, then the government guarantee will be invoked and the difference between what the bank was supposed to get and what the NARCL was able to raise will be paid from the Rs 30,000 crore that has been provided by the government.
Pros of Bad Bank
- Improvement in the bank’s balance sheet of the Banks due to decrease in the NPAs.
- Unlocking of bank capital that was earlier locked up as provisioning requirements. This would lead to an increase in the credit creation.
- Enable the Bank to focus on their core areas of accepting deposits and lending loans. The function of recovery of bad loans gets transferred to the specialist Bad Bank.
- Effective Coordination:
- Most of the NPAs are concentrated in the larger borrowers who have taken loans from multiple banks.
- Presently, such Banks come together to form the Committee of Creditors (CoC) and formulate a resolution plan to recover the NPAs. However, such a mechanism is presently facing problems of coordination and delays in the recovery of NPAs.
- Setting up of Bad Bank would enable the multiple Banks to transfer their NPAs simultaneously to Bad Bank and improve their balance sheets
Cons of Bad Bank
- Moral Hazard: The Bad Bank stands ready to buy NPAs from the Banks. Hence, this would discourage the Banks from exercising due caution in lending loans.
- According to Ex-RBI Governor Raghuram Rajan, the Setting up of Bad Bank would merely lead to transfer of Assets from one entity to another.
- Mismanagement in PSBs: The NPAs of Banks have increased on account of a number of reasons such as Political interference in working of Banks, Increase in willful defaulters, poor recovery process etc. Hence, Bad Bank does not solve the core underlying reasons which led to increase in NPAs in the first instance. The Bad Bank is thus considered to be a superficial solution to the underlying problem of NPAs.
- Dilemma over pricing of NPAs: Higher pricing of Loans Loss to ARC. Lower pricing of Loans Loss to Banks.
- Delays in recovery of NPAs by the ARCs.
Challenges faced by NARCL
- Lower Onboarding of Bad Loans: As of September, 2023, NARCL had made binding offers for 30 accounts, with a total debt exposure of ₹1,69,910 crore. However, it had onboarded only four accounts with an exposure of ₹23,663 crore. While these figures seem substantial, they are a mere fraction when compared to the overall size of the Indian banking system and the NPA challenge it faces.
- Human Resources: In the past 12 months, the institution witnessed four top management changes, raising concerns about its operational stability.
- Apprehension of Banks: Most of the NPAs that NARCL is looking at are vintage NPAs — three years, four years, and so a lot of value erosion has already happened. Hence, banks are often hesitant to sell NPAs to NARCL due to perceived low values.
- Other Challenges: The absence of a vibrant secondary market for SRs and a robust turnaround mechanism for purchased assets undermines confidence among private investors.
Way Forward
Based upon the Global experiences in countries such as US, China, Sweden etc., we need to adopt following strategies to ensure success of NARCL:
- Increasing liquidity of Security Receipts: The desired levels of success of bad banks will greatly depend upon building a secondary market for SRs. Widening the scope of SR participants beyond banks, non-banking finance companies (NBFCs), alternate investment funds (AIFs), asset reconstruction companies (ARCs), and foreign portfolio investors (FPIs) to include high net worth individuals (HNIs), trusts, pension funds, and corporate bodies.
- Role of the Government: Banks need incentives and regulatory support to participate actively in the ARC process. Government can aid in addressing concerns about the impact on balance sheets, by providing financial incentives, tax benefits, or regulatory relaxations to encourage banks to engage more proactively in the Bad Bank’s resolution process.
- Well-Capitalised NARCL: Successful Bad Banks across the world were well-capitalised, which in turn enabled them to take up on the NPAs. Hence, NARCL needs to be well-capitalised to take over NPAs worth Rs 2 lakh crores.
- Realistic valuation of NPAs: Usually, Banks recover only around 10-15% of the fully provisioned loans and haircuts are as high as 85-90%. Hence, Banks should transfer NPAs to NARCL at realistic value.
- Time Bound Resolution of NPAs: Delays in recovery of NPAs would lead to delay in payment of Security Receipts to the Banks and hence adversely affect their financial position.
- Professional Expertise: The NARCL and IDRCL need to have the highest level of professional expertise and calibre to solve NPA mess in a time bound and efficient manner. Fixed and longer tenures of top management will help bring operational stability in NARCL.
- Reforms in PSBs: The setting up of Bad Bank without focussing on reforms in PSBs would mean that the fundamental problems that led to NPAs in first place continue to remain. Hence, recommendations of P.J. Nayak Committee on setting up of Banking Investment Committee has to be expedited.