In the Union Budget for 2021-22, Finance Minister Nirmala Sitharaman had proposed setting up of a bad bank. Crafted as National Asset Reconstruction Company Limited (NARCL), it will bundle up all the non-performing assets (NPAs) of banks and sell them to investors such as private equity funds, alternative investment funds (AIFs) and so on, by putting a turnaround plan in place. On September 16, 2021, she announced the broad contours of the action plan.
Under it, the NARCL will purchase NPAs from banks under 15:85 structure, wherein it will pay up to 15% of the agreed/discounted value of the loans in cash and issue Security Receipts (SRs) for the rest. The Government will provide sovereign guarantee – valid for a period of 5 years – for the SRs issued by NARCL. The guarantee would be invoked to cover the loss being the difference between the realized value (resolution/liquidation) and face value of SRs. A provision of Rs 30,600 crore has been made for this purpose.
The Indian Banks’ Association (IBA) has already started the process with incorporation of the NARCL and applied to the Reserve Bank of India (RBI) for a license as an Asset Reconstruction Company (ARC) with a capital base of Rs 6,000-crore. The public sector banks (PSBs) will have 51% ownership in the NARCL. The remaining shareholding 49% will vest in 16 entities including private banks and non-bank finance companies (NBFCs).
The NARCL is intended to resolve stressed loan assets above Rs 500 crore each amounting to about Rs 200,000 crore. In phase I, it will take over fully provisioned assets of about Rs 90,000 crore while the remaining assets would be transferred in phase II.
High NPAs have been haunting Modi – Government ever since it took charge in 2014. In 2016, it enacted the Insolvency and Bankruptcy Code (IBC) – an overarching law that gives lenders/banks the power to drag defaulting borrowers to a judicial authority (under IBC). It also amended the Banking Regulation Act (BRA) (2017) giving RBI powers to force banks to act within strict timelines.
As per RBI circular dated February 12, 2018, for accounts with aggregate exposure > Rs 2,000 crore, as soon as there was a default in the account with any lender, all lenders — singly or jointly — shall initiate steps to cure the default by preparing a resolution plan (RP). The RP had to be readied within 6 months from the default date. If not, proceedings under IBC would be initiated by referring the case to National Company Law Tribunal (NCLT) which would get 6 months to resolve.
According to a statement by the Minister of State for Finance, Bhagwat K Karad, in Parliament, PSBs alone have recovered over Rs 500,000 crore. NPAs ought to have gone down by this much. But, the decline is only about Rs 200,000 crore – from Rs 1036,000 crore as of March 31, 2018 to Rs 834,000 crore on March 31, 2021. The difference of Rs 300,000 crore is due to fresh slippages. This figure excludes the Covid period viz. March 1, 2020 to March 24, 2021 during which banks were not allowed to recognize bad loans. On their inclusion, we could get back to March 31, 2018 level.
Much lower than expected yield from IBC mechanism has a lot to do with a revised RBI circular dated June 7, 2019 – issued under Supreme Court orders – which took away powers from the banking regulator (those enabled it to force banks act in a time bound manner) and gave too much of flexibility to the latter in working out RP. Effectively, it rendered the IBC process dysfunctional.
Now, the Government wants the ‘bad bank’ do the trick. Look at the first lot of Rs 90,000 crore. These loans being in default for > 3 years, the banks have already made full provision and captured in the profit/loss figures. There is no compulsion on them to recover this money. They won’t object to NARCL paying a very low price.
But, what prevents other asset reconstruction companies (ARCs) from bidding for a higher price. Indeed, the proposed mechanism requires NARCL to go for the ‘’Swiss Challenge’’ auction wherein other ARCs will be invited to better the offer made by it. But, in the present case, this won’t work as the bank would play safe by giving asset to NARCL whose SRs enjoy sovereign guarantee (other ARCs also have issues in making 15% upfront payment in cash).
As for the remaining Rs 110,000 crore for which lower provision 25%/40% has been made (default < one year/1 – 3 years) and the chances of recovery are better, the bank could have reason to offer lower discount on the face value. This is provided transfer happens fast. If, this is delayed and default period increases even exceeding 3 years, the fate of these loans too will be no different from those in the first lot.
In short, the entire bad loan book on offer (read: Rs 200,000 crore) would be available to the ‘bad bank’ at heavy discount to the face value. What if this is fixed at say 18%?
In absolute terms, this works out to Rs 36,000 crore. Of this, NARCL pays 15% or Rs 5400 crore in cash to the banks and for the balance Rs 30,600 crore, it will issue SRs. To redeem these SRs, the former must realize at least Rs 30,600 crore from selling the NPAs to investors. If, the NARCL doesn’t realize even one rupee, then also it need not worry as SRs valued up to Rs 30,600 crore being guaranteed by the Union Government, the latter will pay for it in full.
Short of jargon and high sounding phraseology, the proposed ‘bad bank’ is merely an attempt to use tax payers’ money for bailing out NPAs afflicted banks. Put simply, of the Rs 200,000 crore, the Union Government will give (i) Rs 30,600 crore by way of sovereign guarantee and (ii) the rest (sans a tiny sum of Rs 5400 crore) as direct budgetary support. While, actual release of the amount under (i) depends on when NARCL will invoke the guarantee, as for (ii), the Centre will choose the ‘timing’ and ‘quantum’ of capital infusion depending on its own budgetary position.
The Government should stop taking recourse to disingenuous methods. Instead of following a circuitous route, making things non-transparent, setting up new institutions, adding to administrative and overhead costs and so on, it should candidly accept the dire need to inject that much capital in to the banks and give it from the Budget. During the last 4 years, it gave them Rs 300,000 crore to deal with their NPAs; it can give a further Rs 200,000 crore.
At same time, to recover bad loans and stem their proliferation, it should (i) revitalize IBC mechanism by restoring February 12, 2018 circular and strengthening NCLT (SC indictment of the Centre over their understaffing shows the shambles they are in); (ii) expeditious disposal of challenges to NCLT orders in High Courts and SC; (iii) stepping up ‘tracking’ and ‘surveillance’ within banks for early detection of bad loans including frauds (at present, it takes years for them to report) and (iv) stem corruption and nepotism.
Sans these harsh steps, NPAs tide won’t stop forcing the Government to bail them out repeatedly.