India’s Bad Bank, the National Asset Reconstruction Company Ltd (NARCL), emerged on the scene with great fanfare in mid-2021, heralded as the panacea for the nation’s burgeoning non-performing asset (NPA) crisis. However, despite the initial enthusiasm, NARCL, often colloquially referred to as the Bad Bank, is grappling with challenges, as it endeavours to find its footing in the complex landscape of distressed asset resolution.

As this financial toddler approaches its formative years, questions loom about whether it can stand on its own, or if it still requires the nurturing hand of the government to guide it through this crucial phase. Regardless of the approach chosen, policymakers must vigilantly monitor NARCL’s progress to ensure it stays on course and doesn’t succumb to challenges that could render it ineffective or, worse, comatose.

The government, acting as a concerned parent, has already taken substantial steps to support NARCL’s growth. In September 2021, a government guarantee facility of ₹30,600 crore was instituted for the security receipts (SRs) issued by NARCL. This measure aimed to bolster confidence in the Bad Bank and facilitate its acquisition of distressed assets from lenders.

Understanding the concept of a Bad Bank is crucial to evaluating NARCL’s role. Essentially, it serves as an entity that consolidates a bank’s bad loans or non-performing assets (NPAs) and works towards resolving or liquidating these stressed assets to recover maximum value. In India, NARCL acquires these loans by paying 15 per cent of the amount in cash and the remainder in government-guaranteed SRs, which can be invoked during the resolution or liquidation of bad loans.

Despite these foundational efforts, NARCL has faced operational hurdles and hesitancy from banks to part with their NPAs. In response, Finance and Corporate Affairs Minister Nirmala Sitharaman intervened on December 30, 2023, directing NARCL and banks to expedite the acquisition of stressed assets. This intervention aimed to ensure the Bad Bank doesn’t become a failed experiment.

Snail’s progress

As of September 13, 2023, NARCL had made binding offers for 30 accounts, with a total debt exposure of ₹1,69,910 crore. However, it had onboarded only four accounts with an exposure of ₹23,663 crore. Additionally, it successfully navigated the Swiss challenge in three accounts with an exposure of ₹3,901 crore, while due diligence was underway for another 30 accounts with a combined debt exposure of ₹66,951 crore. While these figures seem substantial, they are a mere fraction when compared to the overall size of the Indian banking system and the NPA challenge it face.

These issues question NARCL’s design, structure, and leadership changes. In the past 12 months, the institution witnessed four top management changes, raising concerns about its operational stability. Industry observers raise doubts over the need for its two-entity structure involving NARCL and India Debt Resolution Company Ltd (IDRCL). A single entity might be more effective, given that the Bad Bank is still waiting for a head start.

Furthermore, the absence of a vibrant secondary market for SRs and a robust turnaround mechanism for purchased assets undermines confidence among private investors.

Charting a turnaround

To ensure NARCL’s success, experts emphasise the urgent need for a secondary market for SRs and a reliable turnaround mechanism. 

PR Jaishankar, Managing Director, IIFCL, noted that there needs to be greater confidence building among investors and a machinery for turnaround needs to be robust. “The desired levels of success of bad bank will greatly depend upon building secondary market for SRs and having robust machinery for turnaround,” he said.

Sanjay Tibrewala, CEO of Phoenix ARC, emphasises that the Bad Bank model in India is yet to establish itself, and is in its early days with only two years gone by since its inception. Developing a market for SRs is essential is his view.

Tibrewala suggests widening the scope of SR participants beyond banks, non-banking finance companies (NBFCs), alternate investment funds (AIFs), asset reconstruction companies (ARCs), and foreign portfolio investors (FPIs) to include high net worth individuals (HNIs), trusts, pension funds, and corporate bodies.

Pricing mismatch

Another issue that needs attention is the mismatch in expectations. As long as there is mismatch between banks and NARCL on the pricing front, performance of NARCL may remain sluggish and below par. To better this problem, Tibrewala’s urges that NARCL needs to be aggressive on pricing for the NPA that it has set its eyes on. 

Banks also need to explore timely disposal of NPAs to ARCs, including NARCL, rather than look at it after the lapse of a few years. This defeats the purpose of effective resolution. Equally, banks, too, need to be reasonable in setting the floor. “To my mind, it finally boils down to the price,” he said.

“Most of the NPAs that NARCL is looking at is vintage NPAs — three years, four years, and so lot of value erosion has already happened,” Tibrewala pointed out and, hence, banks are often hesitant to sell NPAs to NARCL due to perceived low values, need incentives and regulatory support to participate actively. 

Addressing concerns about the impact on balance sheets, the government could consider financial incentives, tax benefits, or regulatory relaxations to encourage banks to engage more proactively in the Bad Bank’s resolution process.

NARCL’s future

In short, NARCL’s future hinges on market-oriented functioning and regulatory support. Developing a secondary market for SRs and setting up a dedicated online trading platform for these instruments could catalyse NARCL from a struggling toddler to an agile and independent competitor in the asset reconstruction arena.