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All you wanted to know about bad bank

Aarati Krishnan | Updated on September 20, 2021

This week, the government’s announcement of providing ₹30,600 crore in guarantees to the new bad bank had banking stocks partying in the markets. The Finance Minister said that the government was willing to provide a backstop to the National Asset Reconstruction Company, against the Security Receipts (SRs) it would issue. What should you make of this legalese?

What is it?

When you spring-clean your home, do you get tempted to throw all the junk into a storeroom so that the remaining rooms look spic and span? The ‘bad bank’ idea works on similar lines. When a bank accumulates too many loans on which borrowers are dodging payments, it thinks of shoving these loans on to a ‘bad bank’ so that it can start off with a clean slate. The government is keen to try out this idea now, given that banks are grappling with legacy bad loans and are now seeing fresh slippages from Covid. The bad bank, designed to take over ₹2 lakh crore worth of NPAs (non-performing assets) from domestic banks was incorporated in July, and is called National Asset Reconstruction Company Ltd. Public sector banks such as Canara Bank, SBI, Bank of Baroda, Bank of India may own 51 per cent of NARCL with other entities holding the rest.

Why is it important?

Indian banks were said to be sitting on over ₹8.3 lakh crore worth of gross non-performing assets or NPAs in March 2021. Covid related defaults are expected to push this number to ₹10-11 lakh crore by March 2022. When banks are dealing with bad loans, their capital and management bandwidth gets tied up and they go slow on lending. Since enhanced credit flow is key to a quick recovery from Covid, a spring-cleaning of bank balance sheets is in order.

The NARCL proposes to buy out ₹2 lakh crore worth of fully-provisioned loans (loans that are carried at zero value in the books), which will immediately reduce the banks’ GNPA burden. After the sale, banks are expected to pursue recoveries on more recent loans and to lend, instead of chasing chronic defaulters. The NARCL, with a large stockpile of stressed loans, is expected to have better clout than individual banks to pursue recoveries.

If it manages to recover something from the bad loans, banks which sold them will get a direct bottomline boost. Given that NARCL is only going to take over fully provided-for loans, it will take them over at a 80-90 per cent haircut. It will not be required to immediately fork out cash. It will pay the banks 15 per cent of the value upfront, paying the balance in Security Receipts (SRs), which will be redeemed as and when recoveries are made against the loans.

The government has now offered to make up the shortfalls between the value of these SRs and actual recoveries up to a sum of ₹30,600 crore. This will make the SRs more valuable for banks holding them and they may get to cash out too. Instead of directly bailing out public sector banks by infusing capital, the government is nudging banks to promote NARCL to rid them of some of their bad loans, while offering some sops to NARCL to smoothen its path.

Why should I care?

The finances of large public sector banks may look better after this clean-up shoring up depositor confidence. The GNPA ratios of banks, particularly public sector banks, which have been creeping up lately, may moderate if they get to transfer some of their legacy bad loans to NARCL. Improved credit flow can give the tentatively recovering economy a leg up. The government will not directly spend taxpayer money to again recapitalise banks.

The bottomline

A bad bank can do some good.

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Published on September 20, 2021

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