A good bank

The Centre’s move to operationalise the National Asset Reconstruction Company Ltd (NARCL), loosely called as a ‘bad bank’, is timely. With Covid-related stress, Indian banks are expected to see a resurgence in their non-performing loans from ₹8.34-lakh crore in end-FY21 to ₹10-11 lakh crore by end of this fiscal. The Cabinet has approved a backstop facility of up to ₹30,600 crore over five years to fill the gap between the value of the security receipts that the NARCL will issue and the realised value of the bad loans it takes over. Government support to NARCL through this backstop facility, instead of through direct capital infusion, is a smart move that avoids immediate capital outgo from its coffers, while minimising moral hazard.

The success of this experiment will hinge on two crucial factors. First, the valuation of the bad loans that the NARCL takes over and, second, the independence and professional expertise that the asset management company — India Debt Resolution Company Ltd — will enjoy. Banks typically recover only 10-15 paise to a rupee against their fully provisioned bad loans, entailing substantial haircuts of 85-90 per cent. It is important that banks transfer bad loans to NARCL at realistic valuations that factor in such haircuts. The government backstop available should not be a factor in influencing this. Remember, the ₹2-lakh crore of loans that will be taken over in the first phase are fully provided-for which means that any realisations by the NARCL will go straight to the bottomline of the concerned bank. To acquire ₹2-lakh crore worth of loans from banks even at an 85 per cent haircut, NARCL will need initial capital. It was expected to start off with ₹6,000 crore with equity participation by banks and non-banks; but it is unclear if this process is complete. The equity will obviously be leveraged to raise the required funds to buy out the initial set of bad loans. The government backstop is important for the NARCL to attract investors, both for equity and for debt.

There is a possibility of conflict of interest arising too. Banks will be part-owners of both NARCL (51 per cent stake) and the asset management company (49 per cent), and they will also be sellers to NARCL. It is important, therefore, that the processes are transparent and that independent market professionals are employed to avoid conflicts. The last thing that the NARCL should be is a sinecure for ex-bankers or for retired civil servants. Finally, the success of this experiment will also hinge heavily on the private asset manager enjoying greater success at resolving legacy bad loans than the banks themselves have so far managed.

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