What is a Bad Bank?

A Bad Bank is floated by lending institutions and/or Government to rid the former’s balance sheet of impaired assets. The identified, fully-provided for stressed assets are transferred by the lending institutions to this so-called Bank at a large hair-cut. Lenders receive a portion of the asset transfer value as upfront cash and the balance as security receipts, which are redeemed over a period of time as and when the resolution of assets happens.

The resolution could entail change and takeover of the management of the borrower’s business, sale or lease of a part or whole of the business of the borrower, rescheduling of payment of debts payable by the borrower, enforcement of security interest, etc. The benefits of transfer of stressed assets include reduction in the proportion of gross non-performing assets (GNPAs), write-back of provisions when the Bad Bank/Asset Reconstruction Company (ARC) manages to make recoveries in the accounts and release of management bandwidth for core banking functions.

Why is India starting one?

Referring to the Twin Balance Sheet problem—overleveraged companies and bad loan-encumbered banks—that India has been trying to solve for some time, the Economic Survey: 2016–17 had observed that decisive resolutions of the loans, concentrated in large companies, have eluded successive attempts at reform. The problem has consequently continued to fester: NPAs keep growing, while credit and investment keep falling. Perhaps it is time to consider a different approach – a centralised Public Sector Asset Rehabilitation Agency that could take charge of the largest, most difficult cases, and make politically tough decisions to reduce debt, the Survey suggested.

So, the formation of a Bad Bank—National Asset Reconstruction Company Ltd (NARCL)—to purge Banks’ balance sheet of stressed loans with total secured outstanding exposure of ₹500 crore and above, both under consortium and multiple banking arrangement should be seen in this context.

Banks will be transferring 15 stressed assets aggregating about ₹50,000 crore by March-end 2022 to NARCL. These are part of the 38 identified stressed assets aggregating ₹83,000 crore that Banks will be transferring to NARCL. Overall, chunky stressed assets aggregating about ₹1.50 lakh crore are expected to be transferred to NARCL.

Why has NARCL been set up despite there being 28 ARCs in the country?

Since NARCL has been formed as a public-private partnership among lenders, decision making at joint lenders’ meetings (JLMs) on transferring chunky stressed assets is expected to be faster. Hitherto, there was a fear that decisions public sector bankers take on transfer of assets to ARCs could come under the lens of the Central Vigilance Commission, leading to an investigation by the Central Bureau of Investigation. NARCL can exorcise these fears.

The existing ARCs will get an opportunity to acquire the assets from the India Debt Resolution Company Ltd (IDRCL), a service company/ operational entity under NARCL which will manage the acquired assets.

How was the Indian financial system dealing with stressed assets till now?

Banks are currently recovering stressed assets through channels such as Lok Adalats, Debt Recovery Tribunals, SARFAESI (Securitisaton And Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002) and cases admitted by the National Company Law Tribunals (NCLTs) under the Insolvency and Bankruptcy Code.

Will a bad bank solve India’s NPA problem?

The bad bank has been floated for the limited purpose of finding resolution to the legacy NPA problem of lenders. Debt aggregation via JLMs is expected to be smoother via NARCL. So, asset transfers to NARCL can take place without much hassle. However, thereafter, the bad bank will employ the same asset resolution tools that ARCs do. So, the success of the bad bank will depend on the efficiency of IDRCL. While NARCL can help clean up the Banks’ balance sheet of legacy assets to an extent, the challenge lies in keeping a tight leash on new stressed assets that could be created due to the impact of the Covid pandemic.

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