Concept of Bad Bank: Bank which takes over the NPAs of the other banks and hence leads to improvement in their financial position.
Global Examples: Early adopter in 1990s- US (Melon Bank) and Sweden (Securum). Similarly, other countries such as Malaysia, Finland, Belgium, Indonesia etc. have set up Bad Banks.
India: The Economic Survey 2016-17 had proposed to set up Bad Bank, which should be called as Public Asset Rehabilitation Agency (PARA). The PARA should be funded and owned by the Government of India. Such a proposal was also put forward by the Indian Banks Association (IBA) recently in June 2020.
Difference between Bad Bank and National Asset Reconstruction Company Limited (NARCL): The Bad Bank, initially proposed by the Economic Survey 2016-17 was to be set and owned by the Government. However, NARCL has been set up by banks themselves. So, one major difference is in nature of ownership. However, since the nature of role performed by them is same, the terms "Bad Bank" and "ARC" can be used interchangeably.
National Asset Reconstruction Company Limited (NARCL): The Asset Reconstruction Companies are registered with the RBI under the provisions of SARFAESI Act. The 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 upto 12 per cent. NARCL would be capitalized through a combination of equity and debt from various Banks and will have a finite life of 5 year
India Debt Resolution Company Ltd. (IDRCL): It has been set up as Asset Management Company (AMC) to deal with NPAs. will have minimum of 51 per cent ownership of Private sector Banks and balance will be held by Public Sector Banks.
Difference between ARC and AMC: The ARC buys the Bad loans from the 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 in NARCL will aggregate and acquire the stressed assets and IDRCL, in turn, will provide stressed assets management and resolution services to NARCL on an exclusive basis. The term of IDRCL shall be co-terminus with that of NARCL.
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 30,000 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.
Why a new ARC has been proposed to be established?
Presently, there are around 28 ARCs, out of which only 3-4 ARCs are well capitalized to take over NPAs worth Rs 500 crores. However, the total NPAs concentrated in 70 large accounts is high as 2-2.5 lakh crores. Obviously, we could have strengthened the existing ARCs to solve this. But the Government believes that a new ARC without any legacy issues would be well equipped to handle this.
RBI's Report on ARCs
Performance Analysis of the ARCs: The ARC industry began with the establishment of the Asset Reconstruction Company India Limited (ARCIL) in 2003. Presently, there are around 28 ARCs which are registered and regulated by RBI.
Poor Recovery rates of just 26% in 2019-20 in comparison to IBC (45%)
Low Percentage of NPAs with ARCs (26%) in comparison to DRTs (33%) and IBC (31%).
Low Capital Base: Majority of the ownership of ARCs lie in the hands of Banks and Financial Institutions. Even though, the Government has allowed 100% FDI through automatic route, ARCs have failed to attract foreign capital.
Higher Borrowings: The ARCs tend to rely heavily on borrowings from the Banks for their funds. The poor financial position of ARCs could have negative domino effect on Banking sector.
Nature of Resolution: The ARCs have relied more on recovery of NPAs through selling-off assets and less on revival of business. ARCs have rarely used change or takeover of the management of business of the borrowers or conversion of borrowers’ debt into equity as measures for reconstruction.
Conflict of Interest: Considering that banks are not just the major shareholders of and lenders to ARCs but also sellers of NPAs to ARCs, there could be circuitous movement of funds between banks and these institutions.
Recommendations
Sale of NPAs at an early stage: Delays in sale of NPAs to ARCs not only leads to erosion in the asset value, but also reduces the probability of reviving genuine companies.
Bring ARCs under IBC:
Under the IBC, the Banks are required to invite applications from different entities for the resolution of NPAs.
However, the current regulatory and legal framework does not allow the ARCs to act as Resolution Applicants (RA) under IBC i.e., they cannot apply for resolution of Bad loans under IBC.
This is inspite of the fact that ARCs can use tools such as change in/takeover of management, debt to equity conversion, etc). Hence, regulations should have to be changed to enable ARCs as Resolution applicants under IBC.
Enhanced Financing Options: The RBI must permit ARCs to raise finances from all regulated entities such as FPIs, Alternate Investment Funds (AIFs), NBFCs as well as retail investors.
Liquidity and Trading of Security Receipts (SRs):
Presently, only the Qualified Institutional Buyers (QIBs) such as Banks, Pension fund, Insurance and Mutual fund companies are allowed to invest in Security receipts (SRs) issued by the ARCs.
To broaden the investor base of SRs, the list of eligible qualified buyers may be further expanded to include High-net worth individuals (HNIs), corporates, NBFCs/HFCs etc.
