For a good ‘bad bank’

| Updated on May 18, 2021

Many operational details need to be thrashed out before the “bad bank” gets started

With borrowers likely to take a renewed hit on incomes from Covid’s second wave, banks that were just beginning to lighten their burden of non-performing assets (NPAs), look set to face a fresh round of defaults which could spike NPAs to double digits. This would once again set off a vicious cycle of loan losses, capital shortfalls and risk aversion at banks. Timely intervention to relieve banks of their legacy bad loans therefore appears imperative now for credit flow to resume when the pandemic abates. The Centre and the banking industry thus need to act quickly to operationalise the ‘bad bank’ idea debated since the Budget. The formation of NARCL (National Asset Reconstruction Company Ltd) and appointment of its CEO mark only baby steps and there are many operational details to be thrashed out if NARCL is to prove more successful than the scores of existing Asset Reconstruction Companies (ARCs).

For NARCL to make a material dent in banks’ bad loans, it will need to be well-capitalised. A recent Reserve Bank of India study on ARCs notes that while most successful ARCs globally have had equity infusions from the government, Indian ARCs relying only on private promoters, have scrounged for capital. With banks reportedly keen to offload ₹2 lakh crore worth of NPAs, the Centre may need to make at least a token contribution to NARCL’s equity capital, while roping in other stakeholders. Two, banks doubling up as key shareholders and/or as lenders to ARCs has led to conflicts of interest, with worries about ARCs acquiring stressed loans at inflated valuations. Should NARCL be promoted exclusively by leading banks, it would fall prey to the same problem. It has been suggested that NARCL conduct an open Swiss auction for every stressed asset it proposes to acquire to get around this, but this will only result in inordinate delays. A dispersed shareholding for NARCL that features neutral parties such as foreign stressed asset investors, may act as a better check against conflicts. While NARCL is likely to stick to the existing industry practice of paying 15 per cent in cash for acquired loans, with 85 per cent in security receipts , the banking lobby appears keen for the Centre to provide a 100 per cent loan loss-guarantee against security receipts. This is inadvisable as it would discourage banks from valuing these loans at realistic prices.

There has also been very little discussion around how NARCL will manage a better recovery record than existing ARCs, which have recovered just 25-35 per cent of loan amounts and have struggled to repossess assets or enforce collateral. For NARCL to do better, legal roadblocks in the way of recovery actions need to be cleared. To pre-empt moral hazard from the Centre repeatedly stepping in to bail out banks, it should also take RBI’s advice and set out a specific mandate and timeline, after fulfilling which the NARCL will be wound up.

Published on May 18, 2021

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