In India, Government-sponsored bad bank has never been tried, though there are several asset reconstruction companies functioning sub-optimally
India’s first-ever government-sponsored “Bad Bank” is now closer to reality. Following the Finance Minister’s announcement in the Union Budget earlier this year, a National Asset Reconstruction Company (NARCL) has been set up to acquire fully provisioned stressed assets worth about Rs 2 lakh crore from various commercial banks in different phases, about a quarter of the total.
Another entity called India Debt Resolution Company Ltd (IDRCL) will then sell these stressed assets in the market to pay back to the banks. Public Sector Banks (PSBs) will have almost half the total shares of both (51 and 49 percent respectively), in which the private sector will also be stakeholders. The initial investment would be around Rs 6,000 crore.
NARCL will buy the buy distressed assets at a discount from the banks by paying 15 percent cash; for the balance 85 percent, they will issue security receipts like debentures, bonds, etc., to the banks. Last month the government had cleared the proposal to provide Rs 30,600 crore to the NARCL as a guarantee for the security receipts to be invoked in case the sale results in a loss to cover the same, but the guarantee will not be valid beyond five years to build in some incentive to accelerate the process of resolution; the guarantee fee to be paid by NARCL will also increase gradually. Since guarantees constitute contingent liability for the government, there would be no immediate fiscal impact or cash outgo for the Centre.
Inherited as a legacy from the past, partly as a fallout of the economic meltdown of 2008 and partly because of crony capitalism which forced many PSBs to give loans without proper assessment of profitability of the relevant project proposals due to which many of these projects either could not materialise or were unable to generate enough income to pay back the loans, the NPAs started mounting. Since 2016, when the RBI tightened the controls on banks and forced them to clean their balance sheets, the NPAs had to be written off or recognised in their balance sheets. This eroded their capital base making them unable to lend afresh, and their profitability was seriously affected.
To keep such banks — mostly PSBs — in business, the government had to recapitalise them from time to time with public finds. Things took a turn for the worse when since 2017 when the economy had started slowing, and the pandemic then delivered the death blow. As per S&P Global Ratings estimate, stressed assets of Indian banks including restructured loans will reach 11-12 percent in 2021-22, up from 8.7 percent at the end of the last fiscal, one of the highest in the world, comparable to Russia or Greece. By taking over the stressed assets and paying the banks which will provide them fresh capital, the bad bank will help the commercial banks to recover a part of their bad loans.
This is a most welcome and a long overdue proposal to resolve the stressed asset problem of banks, private as well as public. The existing acts, viz., the Insolvency and Bankruptcy Code (IBC) 2016 and Reconstruction of Financial Assets and Securitisation and Enforcement of Security Interest (SARFAESI) Act 2002, have proved inadequate for insolvency resolution and to address the problem of NPAs of banks. The SARFAESI Act which enables registration and regulation of Asset Reconstruction Companies (ARCs) by the RBI allows the banks to auction the residential and commercial properties of borrowers to recover outstanding dues. It applies where the borrowing entity is left with neither any revenue source nor an opportunity to resurrect the business, and where no substantial assets are also lying with the guarantors, while a resolution plan under the IBC is intended to put the debtor back on its feet, not simply for recovering the dues of its creditors.As the Supreme Court had said in a case, “the primary focus of the legislation (IBC) is to ensure revival and continuance of the corporate debtor by protecting the corporate debtor from its own management and from a corporate death by liquidation.”
About 4,541 corporates have so far been admitted into the Corporate Insolvency Resolution Process (CIRP), only 1,745 CIRPs have completed the process, either yielding resolution plans or ending up with liquidation. IBC, now five years old and which was suspended during the Covid crisis, is due for an overhaul, including pre-pack for the MSMEs which could later be extended to other companies, allowing a debt resolution mechanism outside the IBC. The existing processes need additional support from other mechanisms, and this is where the band bank fits in.
Bad bank is not a new idea —they have been in existence since the 1980s, but the East Asian currency crisis and the 2008 subprime crisis made many countries to set up bad banks, including the US, Sweden, Finland, Belgium, Malaysia, South Korea, China or Indonesia, but in India the idea of government sponsored bad bank has never been tried earlier, though there are several private Asset Reconstruction Companies which are functioning sub-optimally.
This is another major institutional reform and the Government must be given the credit for it. Whether it will work or not, only time can tell. While it has met with success in many countries, in China they have been struggling, and the collapse of Evergrande is likely to worsen the situation further. In any case, ARCs cannot be a permanent mechanism, indeed it has a sunset clause allowing it to be wound up within five to eight years.
Banking reform has been one major focus area of the government which came up with a 4-R strategy - recognition, resolution, recapitalisation and reforms. After recognition, quantification of NPAs started in a planned manner and banks slowly started recovering their dues. In 2018, just two out of 21 public sector banks were profitable. But in 2021, only two banks (Punjab & Sind Bank and Central Bank) reported losses. As part of the reforms, the government has merged many smaller PSBs with larger ones, and now their total number is stands at 12.
There are several problems, apart from finding potential buyers from the stressed assets of banks. Valuation of the assets is one, which will determine the loss. In fact, there has been some criticism that the government is actually guaranteeing the losses of private enterprises and that the PSBs, being shareholders of both NARCL and IDRCL, will in effect be buying their own stressed assets. So far, the Indian experience has preferred resolution via IBC over the private ARCs, which have a low capital requirement of only Rs 100 crore.
The regulatory environment for the ARCs which has remained practically static ever since they had emerged in the 2000s also needs an overhaul. Stressed assets will not disappear anytime soon, and we need to enable such institutions to help absorb the stressed assets. Economy cannot grow without an adequate supply of credit and creating a level playing field for all.
(The author is former Director General, Comptroller & Auditor General of India and currently a professor at Arun Jaitley National Institute of Financial Management. The views expressed are personal.)
