The Ministry of Finance recently declared that the National Asset Reconstruction Company (NARCL) and the India Debt Resolution Company (IDRCL) will assume the first set of bad loans from banks for resolution. Over the past years, Indian banks have seen significant improvement in their balance sheets with a notable decrease in their Gross Non-Performing Assets (GNPA) ratio from a peak of 11.2% in FY18 to 6.9% in Q2FY22. This article aims to explore the concept of the Bad Bank, the role played by NARCL and IDRCL, the benefits and challenges associated with this model, and the future implications for the Indian banking sector.
Understanding Non-Performing Assets (NPA) and Bad Bank
Non-Performing Asset (NPA) refers to loans or advances that are either in default or are in arrears on scheduled payments of principal or interest. Debt is generally categorized as non-performing if loan payments have not been made for at least 90 days. On the other hand, a bad bank is a financial institution established to buy NPAs, or bad loans, from banks with the objective of relieving them from the burdensome loans and encourage fresh lending.
Role of NARCL and IDRCL
The NARCL has been established by banks to consolidate and aggregate stressed assets for their subsequent resolution, with Public Sector Banks (PSBs) maintaining 51% ownership. Conversely, IDRCL is a service entity that manages the asset and hires market professionals and turnaround specialists. For the IDRCL, Public Sector Banks (PSBs) and Public FIs will hold a maximum of 49% stake while the rest will be with private sector lenders. The government has previously announced sovereign guarantees of Rs 30,600 crore for Security Receipts (SRs) to be issued by NARCL, which will be buying Rs 2 lakh crore non-performing loans from banks.
Pros and Cons of a Bad Bank
The concept of a bad bank offers several advantages and disadvantages. On the pro side, it can consolidate all bad loans under a single exclusive entity, free the capital locked in by banks as provisions against these bad loans, and improve banks’ capital buffers by freeing up capital. On the downside, it may merely shift bad assets from public sector banks to a government-owned bad bank, which does not solve the root problem of the bad loan crisis. Also, it introduces a risk of moral hazard whereby commercial banks bailed out by a bad bank may continue reckless lending practices.
Challenges Associated with the Bad Bank Concept
Mobilising capital, particularly in a pandemic-hit economy will pose a challenge. Furthermore, without proper governance reforms, public sector banks may continue piling up bad debts. Additionally, market-related issues such as non-market determined asset transfer prices from commercial banks to the bad bank complicate price discovery. The issue of provisioning has been addressed through recapitalization, with the Union Government infusing nearly Rs 2.6 lakh crore in banks over the past few years.
Way Forward
A bad bank can be a good solution only if the underlying structural problems in the banking system are identified and resolved. The key lies in ensuring that Public Sector Banks’ management is autonomous from political and bureaucratic influence to maintain professionalism and adhere to prudential lending norms. Unless this transformation occurs, the benefits derived from a bad bank model will remain limited.