With the recent authorization of a Rs 30,600 crore guarantee by the Union Cabinet, Security Receipts issued by the National Asset Reconstruction Company Limited (NARCL) are set to acquire stressed loan assets. The NARCL plays a pivotal role in a newly devised bad bank structure introduced in the Budget 2021.
Understanding the New Structure: NARCL and IDRCL
This new framework was established in response to the rising number of Non-Performing Assets (NPAs) plaguing India’s banking sector. NPAs denote loans or advances that have been defaulted or fallen behind schedule.
The government has put forth two entities to undertake stressed assets from banks and subsequently market them. This is where the NARCL and the India Debt Resolution Company Ltd (IDRCL) come in. Incorporated under the Companies Act, NARCL plans to obtain stressed assets worth around Rs 2 lakh crore from diverse commercial banks in numerous phases. This entity will be chiefly owned by Public Sector Banks (PSBs), holding 51% of ownership.
Meanwhile, IDRCL’s primary function will be marketing these stressed assets. Its ownership distribution allows for maximum 49% stake by PSBs and Public Financial Institutes (FIs). The remaining 51% will fall under the jurisdiction of private-sector lenders. The synchronized operations of NARCL and IDRCL translate into the new bad bank structure.
Reasoning Behind the NARCL-IDRCL Structure
In the quest to resolve stressed assets, current ARCs have demonstrated usefulness, especially concerning smaller value loans. Mechanisms like the Insolvency and Bankruptcy Code (IBC) also have proven effective in this endeavor. However, given the significant volume of legacy NPAs, more alternative options were needed, prompting the announcement of the NARCL-IRDCL structure in the Union Budget 2021.
Functioning and Guarantee of NARCL-IDRCL
The operation begins with NARCL buying bad loans from banks, with 15% paid in cash and the remaining 85% as Security Receipts. With IDRCL’s assistance, these assets are sold, and commercial banks are compensated. If NARCL fails to sell or sells at a loss, the government guarantee is invoked. The amount provided by the government serves to fill the financial gap. This Rs 30,600 crore guarantee is valid for five years.
Understanding Bad Banks
A bad bank, either an Asset Reconstruction Company (ARC) or an Asset Management Company (AMC), takes over commercial banks’ bad loans, manages them, and recovers the money over time. It aids in clean up of balance sheets and resolution of problematic loans while not involving in lending or deposit-taking.
Impact of Bad Bank
Setting up a bad bank can be beneficial for commercial banks struggling with high NPA levels as it allows them to shed their toxic assets in one go, boosting profits. However, there are concerns from a government and taxpayer perspective since the money involved originates from taxpayers. The only sustainable solution lies in improving the lending operation in PSBs.
Moving Forward
While a bad bank is a step towards resolving the issues at hand, tackling the underlying structural problems in the banking system and initiating relevant reforms are the keys to a long-term solution. Public Sector Banks must operate independently from political influence to maintain creditable professionalism and prudential norms in lending.
