In the Union Budget for 2021-22, the Finance Minister, Nirmala Sitharaman has proposed setting up of a bad bank. Crafted as an asset reconstruction company (ARC), it will bundle up all the non-performing assets (NPAs) of banks, buy these at a negotiated (albeit discounted) price and sell them to investors such as alternate investment funds (AIFs) etc by putting a turnaround plan in place. An asset management company (AMC) will work on the details.
The banks plan to transfer nearly Rs 200,000 crore of bad loans to the ARC. In return, the ARC will provide 15% upfront cash to banks, and issue security receipts (SRs) for the remaining 85%, to be guaranteed by the Government. The ARC will require a capital infusion of at least Rs 10,000 crore. A majority share holding in the entity will be held by public sector banks (PSBs).
According to the 22nd Financial Stability Report (FSR) released by the Reserve Bank of India (RBI), the gross NPAs (GNPA) ratio of all scheduled commercial banks (SCBs) is projected to increase from 7.5% in September 2020 to 13.5% by September 2021. In this backdrop, Sitharaman has justified the proposal in terms of the dire need to unshackle the banks and equip them to increase lending for supporting the so called V – shaped recovery.
Does a bad bank offer a sustainable solution? Are not alternative options available? Have any of those been tried? What has been the outcome? What is the way forward?
At the outset, it is important to note here that bad loans haunted the banks even prior to the current year which is reeling under the Corona Pandemic. In the follow up to the asset quality review (AQR) initiated by the RBI in 2015, the GNPA ratio had touched a high of 11.2% as on March 31, 2018.
To deal with it, Modi – Government had implemented a number of legislative measures such as enactment of the Insolvency and Bankruptcy Code (IBC) and amendment of the Banking Regulation Act (BRA) etc. Effective use of IBC – duly supported by the amended BRA (this gave the RBI sweeping powers to force banks to act) led to resolution of dozens of NPA accounts thereby helping lenders to recover over Rs 3,00,000 crore. These efforts got reflected in lowering of GNPA ratio to 8.5% as of March 2020 which further declined to 7.5% by September 2020.
Yet, the idea of a bad bank was floated as far back as January 2017 when the Economic Survey mooted setting up a public sector asset rehabilitation Agency. In 2018, a committee under the former Chairman, Punjab National Bank (PNB), Sunil Mehta, recommended setting up of an AMC to be named ‘Sashakt India Asset Management’ for fast track resolution of large bad loans. In May, 2020, the Indian Banks Association (IBA) resurrected this idea with a proviso that the Union Government should anchor the bad bank with majority equity holding. The RBI, too, suggested formation of two entities viz. a private AMC and a national AMC to clean up NPAs of ailing PSBs.
It defies logic as to why this idea was being pursued even when the IBC was delivering good results. It is argued that this process involves delays and results in reduction in proceeds from sale of assets. To set the record straight, under IBC, 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 approved by all lenders had to be readied within six months from the default date. If the deadline was missed, proceedings under IBC would be initiated by referring the case to the National Company Law Tribunal (NCLT) which would get six months to complete the resolution process.
There could not have been a more potent way to resolve stressed asset. The banks got 6 months to do the job; if they didn’t, the NCLT will have to do it for which it got 6 months. Therefore, at the outer limit, it was one year to get resolution kicking. The best part was the Tribunal was to sell the defaulter’s firm as a ‘going concern’ so that it gets maximum realization. The results are there for all to see (wherever delays happened, those were due to the cases being taken to courts – either by the promoter or competing suitor).
Ironically, on April 2, 2019, Supreme Court (SC) quashed the above circular and ordered the RBI to come up with fresh guidelines. The revised circular dated June 7, 2019 gives lenders 30 days to enter into an inter-lender agreement (ILA) to decide on a RP. After this, they get 180 days to come up with RP; if they don’t, they are only required to make an additional provision of 20%. If, they don’t finalize within 365 days, they have to make an additional 15% provision. In short, unlike the February 12, 2018 guidelines, banks are not obliged to refer the case to NCLT in a time bound manner. This has literally rendered resolution under the IBC process dysfunctional.
The RBI’s decision to grant moratorium on loan repayments (March 1 – August 31, 2020) and exclude the moratorium period for the purpose of declaring an account as NPA has made matters worse. Furthermore, the SC diktat of not treating any account as NPA even after August 31, 2020 – till further orders – has not only put a lid on ‘how the bad loan scenario looks like’, by painting every account with the same brush, it has also incentivized those borrowers who were unaffected by the pandemic, not to pay up.
From these trends, it is clear that neither banks are being goaded to rein in proliferation of NPAs nor they are made to accept the rigors of IBC for dealing with these. Now, comes the bad bank which will enable them completely abdicate their responsibility.
It takes over their bad loans for a price. The banks will receive full payment viz. 15% upfront cash plus SRs for 85%. The SRs being guaranteed by the Union Government, they need not also make any additional provision (sans guarantee, they would have to do it as per RBI circular dt September 1, 2016). Even the bad bank need not worry much when it comes to recovering the money from sale of assets. In view of sovereign guarantee for 85% of the price it gives to bank as SRs, its own skin in the game is a mere 15%.
Earlier, while rejecting the IBA proposal, the Government had opined, it had no intent of getting involved in the bad bank. Now, doing a volte face, it has decided to become anchor investor – albeit indirectly – through PSBs who will own majority equity. Further, by promising sovereign guarantee for as high as 85% of loan price, it has literally agreed to foot the bill. If, that is the real intent, why not give the capital directly instead of following a circuitous route!
But, that will ruin the Budget. The only sustainable solution to bad loan problem is to strictly adhere to the IBC process – as per the February 12, 2018 RBI circular.