The proposed ‘bad bank' scheme by the Government is merely an attempt at using taxpayers' money for bailing out NPA-afflicted banks

In the Union Budget for 2021-22, Finance Minister Nirmala Sitharaman had proposed setting up of a bad bank. Crafted as National Asset Reconstruction Company Limited (NARCL), it will bundle up all the non-performing assets (NPAs) of banks and sell them to investors such as private equity funds, alternative investment funds (AIFs) and so on, by putting a turnaround plan in place. On September 16, 2021, she announced the broad contours of the action plan.

Under it, the NARCL will purchase NPAs from banks under 15:85 structure, wherein it will pay up to 15 per cent of the agreed or discounted value of the loans in cash and issue Security Receipts (SRs) for the rest. The Government will provide sovereign guarantee - valid for a period of 5 years - for the SRs issued by NARCL. The guarantee would be invoked to cover the loss being the difference between the realized value (resolution/liquidation) and face value of SRs. A provision of Rs30,600 crore has been made for this purpose.

The Indian Banks’ Association (IBA) has already started the process with incorporation of the NARCL and applied to the Reserve Bank of India (RBI) for a license as an Asset Reconstruction Company (ARC) with a capital base of Rs6,000-crore. The public sector banks (PSBs) will have 51 per cent ownership in the NARCL.The remaining shareholding will vest in 16 entities including private banks and non-bank finance companies.

The NARCL is intended to resolve stressed loan assets above Rs500 crore each amounting to about Rs200,000 crore. In phase I, it will take over fully provisioned assets of about Rs90,000 crore while the remaining assets would be transferred in phase II.

High NPAs have been haunting the Modi Government ever since it took charge in 2014. In 2016, it enacted the Insolvency and Bankruptcy Code (IBC), an overarching law that gives lenders and banks the power to drag defaulting borrowers to a judicial authority. It also amended the Banking Regulation Act  giving RBI powers to force banks to act within strict timelines.

As per RBI circular dated February 12, 2018, for accounts with aggregate exposure of over Rs2,000 crore, as soon as there was a default in the account with any lender, all lenders - singly or jointly - shall initiate steps to cure the default by preparing a resolution plan. The plan had to be readied within 6 months from the default date. If not, proceedings under IBC would be initiated by referring the case to National Company Law Tribunal (NCLT) which would get six months to resolve.

According to a statement in parliament by Minister of State for Finance Bhagwat K Karad, PSBs alone have recovered over Rs500,000 crore. The NPAs ought to have gone down by this much but the decline is only about Rs200,000 crore and the difference of Rs300,000 crore is due to fresh slippages. This figureexcludes the Covid period — March 1, 2020 to March 24, 2021 — during which banks were not allowed to recognize bad loans. On their inclusion,we could get back to March 31, 2018 level.

Much lower yield than expected from the IBC mechanism has a lot to do with a revised RBI circular dated June 7, 2019 — issued under Supreme Court orders - which took away powers from the banking regulator and gave too much of flexibility to the latter in working out the resolution plan. Effectively, it rendered the IBC process dysfunctional.

Now, the Government wants the ‘bad bank’ do the trick. Look at the first lot of Rs90,000 crore. These loans being in default for over 3 years, the banks have already made a full provision and captured in the profit and loss figures. There is no compulsion on them to recover this money. They will not object to NARCL paying a very low price.

However, what prevents other asset reconstruction companies (ARCs) from bidding for a higher price. Indeed, the proposed mechanism requires NARCL to go for the “Swiss Challenge” auction wherein other ARCs will be invited to better the offer made by it. However, in the present case, this will not work as the bank would play safe by giving asset to NARCL whose SRs enjoy sovereign guarantee.

As for the remaining Rs110,000 crore for which a lower provision has been made and the chances of recovery are better, the bank could have reason to offer lower discount on the face value. This is provided transfer happens fast. If, this is delayed and default period increases even exceeding three years, the fate of these loans too will be no different from those in the first lot.

In short, the entire bad loan book on offer (read: Rs200,000 crore) would be available to the ‘bad bank’ at heavy discount to the face value. What if this is fixed at say 18 per cent?

In absolute terms, this works out to Rs36,000 crore. Of this, NARCL pays 15 per cent or Rs5400 crore in cash to the banks and for the balance Rs30,600 crore, it will issue SRs. To redeem them, the former must realize at least Rs30,600 crore from selling theNPAs to investors. If, the NARCL doesnot realize even one rupee, then also it need not worry as SRs valued up to Rs30,600 crore being guaranteed by the Union Government, the latter will pay for it in full.   

Short of jargon and high-sounding phraseology, the proposed ‘bad bank’ is merely an attempt to use tax payers’ money for bailing out NPAs afflicted banks. Put simply, of the Rs 200,000 crore, the Union Government will give Rs30,600 crore by way of sovereign guaranteeand the rest (sans a tiny sum of Rs5400 crore)as direct budgetary support.

The Government should stop taking recourse to disingenuous methods. Instead of following a circuitous route, making things non-transparent, setting up new institutions, adding to administrative and overhead costs and so on, it should candidly accept the dire need to inject that much capital in to the banks and give it from the Budget. During the last four years, it gave them Rs300,000 crore to deal with their NPAs; it can give a further Rs200,000 crore.

At the same time, to recover bad loans and stem their proliferation, first, it should revitalisethe IBC mechanism by restoring the February 12, 2018 circular and strengthening the NCLT; secondly, expeditious disposal of challenges to NCLT orders in High Courts and SC; thirdly, stepping up ‘tracking’ and ‘surveillance’ within banks for early detection of bad loans including frauds (at present, it takes years for them to report) and lastly, stem corruption and nepotism.   

Sans these harsh steps, the tide of NPAs will not stop forcing the Government to repeatedly bail them out.

(The writer is a policy analyst. The views expressed are personal.)