Role of Bad bank in resolving the issue of stressed assets
- A key proposal announced in this year’s (2021) Budget, a bad bank to deal with stressed assets in the loss-laden banking system, has received all regulatory approvals.
- The bad bank — National Asset Reconstruction Company Limited — is ready to commence operations with 15 cases worth Rs 50,335 crore to be transferred by March 31.
Structure of the bad bank
- NARCL (National Asset Reconstruction Company Limited) will acquire and aggregate the identified NPA accounts from banks, while IDRCL (India Debt Resolution Co. Ltd), under an exclusive arrangement, will handle the debt resolution process.
- Padmakumar Nair, a Chief General Manager from SBI’s Stressed Assets vertical, will manage NARCL, while Manish Makharia, Head of Alternate Investment Fund, SBI Funds Management Pvt Ltd, will head IDRCL.
- Subrata Biswas, the nominee director on the Board of NARCL, will be the interim Chairman, and Diwakar Gupta will continue as the Chairman of IDRCL.
- Majority-owned by state-owned banks, the NARCL will be assisted by the India Debt Resolution Company Ltd (IDRCL), in turn majority-owned by private banks, in resolution process in the form of a Principal-Agent basis.
Working of bad bank work and Principal-Agent mechanism
- NARCL and IDRCL will have an exclusive arrangement that will be as per the scope defined in the ‘Debt Management Agreement’ to be executed between these two entities.
- This arrangement will be on a ‘Principal-Agent’ basis and final approvals and ownership for the resolution shall lie with NARCL as the Principal.
- With the ‘Principal and Agent mechanism’ that has been put in place to address regulatory concerns, the final approvals will still be done by NARCL as the Principal.
- IDRCL is majority-owned by private banks but the final authority will rest with NARCL, which is majority-owned by public sector banks.
- This has been done possibly to address regulatory concerns around the bad bank structure.
- An Asset Reconstruction Company and Asset Management Company would be set up to consolidate and take over the existing stressed debt and then manage and dispose of the assets to Alternate Investment Funds and other potential investors for eventual value realisation.
- The asset resolution will be done in a phased manner.
- A total of 38 accounts aggregating Rs 82,845 crore have been identified for transfer to NARCL.
- In the first phase, at least 15 accounts worth Rs 50,335 crore will be transferred to the proposed bad bank by March 31.
- Initially, an estimated Rs 2 lakh crore worth of bad assets was planned to be transferred; however, some of these accounts have already been resolved and further resolutions will happen as and when referred to the bad bank.
- With a combination of post-Covid moratorium and recoveries, there was an actual decline in NPAs from Rs 8.40 lakh crore in 2020 to Rs 7.80 lakh crore in 2021.
- IDRCL is expected to bring in superior resolution techniques, preserve the value, showcase brownfield assets, and attract domestic as well as foreign investors, Alternate Investment Funds, etc.
- This will free up capital for further bank lending.
Role of Government
- The NARCL will purchase these bad loans through a 15:85 structure, where it will pay 15% of the sale consideration in cash and issue security receipts (SRs) for the remaining 85%.
- The SRs will be guaranteed by the government which will essentially cover the gap between the face value of the security receipts and realised value of the assets when eventually sold to the prospective buyers.
- The government approved a 5-year guarantee of up to Rs 30,600 crore for security receipts to be issued by NARCL as non-cash consideration on the transfer of NPAs.
- This will address banks/RBI concerns about incremental provisioning.
- Government guarantee, valid for five years, helps in improving the value of security receipts, their liquidity and tradability.
- A form of contingent liability, the guarantee does not involve any immediate cash outgo for the central government.
- As long as Public Sector Banks’ managements remain beholden to politicians and bureaucrats, their deficit in professionalism will remain and subsequently, prudential norms in lending will continue to suffer.
- Therefore, a bad bank is a good idea, but the main challenge lies with tackling the underlying structural problems in the banking system and announcing reforms accordingly.