The Reserve Bank of India (RBI) has yet to approve the implementation of the proposal for the establishment of a ‘Bad Bank.’ In September 2021, the Union Cabinet had issued approval for a Rs. 30,600 crore guarantee to back Security Receipts issued by National Asset Reconstruction Company Limited (NARCL) for obtaining stressed loan assets.
Understanding NARCL & IDRCL
Licensed by RBI, the NARCL has been established to function as an Asset Reconstruction Company (ARC). It aims to acquire stressed assets approximating Rs 2 lakh crore from various commercial banks in stages. Public Sector Banks (PSBs) will retain 51% ownership in NARCL.
Simultaneously, the India Debt Resolution Company Limited (IDRCL) has been established. This separate company will function as an Asset Management Company and assist in managing and resolving assets, aiding in price discovery and the evolution of optimal recovery and resolution processes. IDRCL will be majority owned by private-sector lenders (51%) and PSBs and Public Financial Institutes (FIs) will hold the remainder.
Functioning of the Dual Structure
The NARCL purchases bad loans from banks at an agreed price, paying 15% in cash and the remaining 85% in the form of “Security Receipts”. When these are sold, with assistance from the IDRCL, the commercial banks receive the remainder of their payments. If the bad bank is unable to sell the bad loan or sells it at a loss, the government guarantee will be invoked. The difference between what the commercial bank was set to receive and what the bad bank raised will be covered by the Rs 30,600 crore provided by the government – a guarantee that extends for five years.
Stipulations of Indian Banks
Typically, a single entity is responsible for both ownership and recovery of the assets. The Indian Banks’ Association has proposed a dual structure with the AMC as a privately-held entity that operates outside the jurisdiction of regulatory entities, but this isn’t favoured by the RBI.
RBI’s Reservation
RBI prefers a model where one entity acquires non-performing loans and also reaches a resolution. The current proposal involves two separate entities: NARCL and IDRCL which creates operational issues and challenges pertaining to ownership structure.
Role of Bad Bank
A bad bank, either an ARC or an Asset Management Company (AMC), takes over the bad loans of commercial banks, manages them and recovers the money over time. While not involved in lending or taking deposits, bad banks help commercial banks clean up their balance sheets and resolve bad loans. Usually, the takeover of bad loans is below the book value of the loan.
Effects of Bad Bank
From the perspective of commercial banks, setting up a bad bank will be beneficial in managing high levels of Non-Performing Assets (NPA). By selling off toxic assets, these banks can improve their profits and start lending again.
However, from the perspective of the government and taxpayers, money used for recapitalising PSBs or giving guarantees for security receipts essentially comes from taxpayers. The ultimate solution requires improvement in the lending operation in PSBs. Failure to sell impaired assets in the market would ultimately burden the taxpayers.
Way Forward
While a bad bank may seem like a good idea, the primary challenge lies in tackling underlying structural problems within the banking system and implementing necessary reforms. As long as Public Sector Banks’ managements continue to be influenced by politicians and bureaucrats, the professionalism deficit will exist and prudential norms in lending will suffer.
Last Modified: February 15, 2024