Reserve Bank of India is expected to give permission for bad bank within two months. To be co-owned by a consortium of public sector and private banks, the National Asset Reconstruction Company Ltd will work in parallel with IBC to deal with the expected surge in non-performing assets in the aftermath of the Covid-19 pandemic.
After enacting the Insolvency and Bankruptcy Code (IBC) in 2016 to deal with corporate insolvency and resolve the problem of delinquent loans clogging up the Indian banking sector, the Narendra Modi government is taking aim once again at the problem of non-performing assets (NPAs) that is holding bank Indian lenders – this time in the form of the much-debated bad bank.
The Indian Banks’ Association (IBA), the apex association of commercial banks in India, has sought permission from the Reserve Bank of India (RBI) to set up the National Asset Reconstruction Company Ltd (NARCL) capitalised at $800 million. The approval from the central bank for NARCL to begin operations is likely to come within two months.
This new bad bank will work in parallel with the IBC to help lenders recover as much of the outstanding loans to delinquent borrowers as possible. It will buy delinquent loans from mostly public sector lenders and then look to restructure these loans and try to resolve them. There are plans to draw investments from alternative investment funds run by private equity investors to finance the operations of NARCL.
READ MORE ON INDIA & BANKING:
Billions at stake, Modi govt must find a middle path to resolve this banking crisis
Banking on better financial lending to combat climate change
Citi exit from Indian consumer banking opens up new prospects for fintech cos
UK banks on India’s virtual support for G7 sessions
This new bad bank will work in parallel with the IBC to help lenders recover as much of the outstanding loans to delinquent borrowers as possible. It will buy delinquent loans from mostly public sector lenders and then try to resolve them. It will draw investments from alternative investment funds run by private equity investors to finance its operations.
According to a back of the envelope calculation, public sector banks are planning to transfer about $27 billion worth of delinquent or stressed assets to NARCL – a combination of NCLT cases, NPAs and loans that have already been written off.
But this amount is only the tip of the iceberg. At the beginning of 2020-21, when India was a week into the world’s most stringent lockdown, the country’s banking sector was struggling with NPAs that were 8 per cent of total outstanding loans.
Since then, loan moratoriums and relief measures announced by the Ministry of Finance and the Reserve Bank of India (RBI) have stemmed the growth of this percentage to a much larger proportion of outstanding credit, but the stress in the system is palpable and needs to be addressed on a war footing to put India back on the fast growth trajectory.
The track record of bad banks across the world, however, is mixed. Two of the most successful examples comes from Sweden and South Korea. In the 1990s, Sweden set up such a company backed by the government. It recovered 90 per cent of delinquent loans within six years.
Another successful example is the Korea Asset Management Corporation, which was set up in the aftermath of the 1996-97 East Asian currency crisis. It earned huge profits over a period of five years by successfully turning NPAs around.
On the other hand, Malaysia, which set up two such companies around the same time as South Korea had to shut them down after a few years, while a Chinese government-led company is in trouble and is seeking a bailout.
The track record of bad banks across the world is mixed. Sweden and South Korea earned huge profits over a period of five years by successfully turning NPAs around. On the other hand, similar companies set up by Malaysia and China either had to be shut down or are seeking a bailout.
From these examples, two key factors emerge. One, the bad banks have to have a clearly defined purpose and secondly, they must have a sunset clause, a defined time frame within which they must be mandated to complete their task and move on.
As mentioned above, proactive steps by the government and the central bank have precluded the worsening of the NPA crisis at banks. With the IBC, despite some high-profile successes, still struggling to meet resolution deadlines mandated under the law, the NARCL could provide an alternative pathway to resolving India’s mounting bad loan woes.
Announcing this in her Budget speech in February, Finance Minister Nirmala Sitharaman had said: “An Asset Reconstruction Company Limited and Asset Management Company would be set up to consolidate and take over the existing stressed debt. It will manage and dispose the assets to alternative investment funds and other potential investors for eventual value realisation.”
READ MORE ON INDIA AND FINANCE:
India's GIFT to global finance gains traction
The case for crypto: Can India embrace digital currencies?
India’s homegrown UPI for instant money transfer will go global soon
India takes first step towards its own digital currency with e-Rupi
Some critics say the structure of NARCL means public sector banks will at least partially buy their own bad loans at a discount. This is technically correct, but it misses the woods for the trees – that individual banks may not have the wherewithal to deal with large NPAs on their books, whereas NARCL is a vehicle specifically set up to resolve this very issue.
NARCL will be 51 per cent owned by public sector banks and 49 per cent by those in the private sector. The state-owned Canara Bank will be leader sponsor with a 12 per cent stake in the bad bank.
The company will only buy those stressed assets for which banks have already made 100 per cent provisions in their books.
Some critics have, however, complained that the structure of NARCL means public sector banks will at least partially buy their own bad loans at a discount. This is technically correct, but it misses the woods for the trees. The point it misses is that individual banks may not have the wherewithal to deal with large NPAs on their books, whereas NARCL is a vehicle specifically set up to resolve this very issue.
However, as the examples of Sweden, South Korea, Malaysia and China show, the mere setting up of a bad bank and an asset management company cannot be the panacea for bad credit policies practised in the past. The best personnel, well versed in the art of resolving stressed assets, have to be brought in and given due independence and responsibility to make this move successful.
Given that both the Ministry of Finance and Reserve Bank of India are on board this initiative, there is reason for optimism.