Why A 'Bad Bank' Is Not Bad At All

·5-min read

The union government has now cleared a Rs 30,600 crore guarantee programme for securities to be issued by NARCL for taking over and resolving Rs 2 lakh crore worth non-performing assets.

In a step further to clean up the banking system of the country, the union government on Wednesday (15 September) cleared a security guarantee programme for the newly incorporated 'bad bank'.

The National Asset Reconstruction Company Limited (NARCL), incorporated under the Companies Act combined with India Debt Resolution Company Ltd (IDRCL), would be India's first-ever bad bank. NARCL will acquire stressed assets from various commercial banks in different phases, worth about Rs 2 lakh crore.

Private sector asset reconstruction firms (ARCs) may also be allowed to outbid the NARCL by making an offer to the lead bank.

The IDRCL will manage the acquired assets, try to raise their value for final resolution, and sell them in the market. Public and private lenders would combine forces to set up the company.

While there are 28 ARCs in the private sector, Finance Minister Nirmala Sitharaman said there was a need for government-backed receipts for big ticket resolutions.

The NARCL is reportedly in the process of getting a license from the RBI, following which toxic assets worth Rs 90,000 crore that banks have already fully provided for will move to the NARCL.

The union cabinet has now cleared a Rs 30,600 crore guarantee programme for securities to be issued by NARCL for taking over and resolving Rs 2 lakh crore worth non-performing assets (NPAs).

The Backstop Arrangement

When the NARCL acquires an asset (bad loan) from the bank, it will pay 15 per cent of the agreed price in cash, and the remaining 85 per cent will be in the form of security receipts. When the assets are sold, with the help of IDRCL, the bank will be paid back the rest of the amount.

In case the bad loan doesn't get sold or is sold at a loss, the government guarantee will be invoked, and the difference between what the bank was supposed to get and what the bad bank was able to raise will be paid from the Rs 30,600 crore that the government has provided.

Finance Minister Nirmala Sitharaman was quoted as saying by The Hindu:

"A 15 per cent cash payment would be made to the banks based on some valuation and the rest will be given as security receipts. For those to hold on and have their value intact, there is a need for the government to give a back-stop arrangement and that is why this Rs 30,600 crore has been cleared by the Cabinet."

"Once the NARCL and the IDRC have finally resolved the asset, preferably as a going concern and not through liquidation proceedings, the Minister said the balance 85 per cent held as security receipts would be given to the banks."

The FM also clarified that there is a five-year limit on the guarantee. "The government back-stop will come in only as much as to pay the gap between the realised value and the face value of those receipts and this will hold good for only five years," she said.

Also, as an incentive for the resolution process to be completed at the earliest, the fees charged for the guarantee will increase every year.

What Next

The government is hoping that the value locked in the assets is realised and comes back to the banks; they use it as a growth capital, and the banking system becomes more robust.

"In all probability, some assets may have an upside, [and] by using the guarantee as a backstop, the entire upside will also come to the banks rather than getting retained by the NARCL," the Financial Services Secretary said.

The Cabinet's decision, to extend a five-year guarantee for NARCL-issued security receipts to banks, completed the entire cycle of cleaning up India's banking system that began with the recognition of the extent of bad loans in 2015, Sitharaman said.

"We have addressed the issues facing the banking system in totality that in 2015 was a major challenge for the economy. The twin balance sheet problem which caused a lot of stress … today, we have resolved this in a holistic way. Within those five years, all these [NPAs] will have to be resolved," she emphasised.

Experts pointed out that the announcement is a positive stepping stone for unlocking stressed assets' value and the upfront cash payment by the NARCL will immediately be accretive for the profitability and capital of the banks, however, the bad bank's success would ultimately be decided by the ability of the NARCL to resolve stressed assets in a time-bound manner and the implementation and management of the transferred NPAs by the IDRC.

If the bad bank fails to sell the assets, government will have to use taxpayers' money to recapitalise it, just like with the commercial banks.

The good news is, after getting rid of their toxic assets in one quick move, the banks can start lending again, giving a much-needed boost to the economy and starting a virtuous cycle. The recovery money they are expected to get will further improve their position.

In the longer term, improving the lending operations in the public sector banks - to avoid the build up of NPAs - is the only sustainable solution.

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