The Good, the Bad and the Ugly

By Shivanand Pandit

Taking forward one of her statements made during the 2021 Budget, Finance Minister Nirmala Sitharaman recently declared the creation of India’s first-ever “Bad Bank”. She said the National Asset Reconstruction Company Limited (NARCL) had already been incorporated under the Companies Act and would procure strained assets worth approximately Rs 2 lakh crore from different commercial banks in various stages. India Debt Resolution Company Limited (IDRCL), another new entity, will attempt to dispose of the strained assets in the market. The NARCL-IDRCL configuration is the novel bad bank and to make it a reality, the government has allowed the utilisation of Rs30,600 crore as guarantee.

Many banks have seen a progressive increase in their loans ever since the international financial disaster of 2008-2009. In India, since 2016, the level of non-performing assets (NPAs) or bad loans has climbed steeply. Largely, this was because the RBI wants banks to precisely identify bad loans and record them in their books of accounts. In 2020-21, total NPAs of PSU banks stood at Rs 6.17 trillion. Thus, there is now no probability of receiving payment of that amount and banks must make provision for the sick days ahead.

The troublesome fact is that a vast share of NPAs is with PSU banks which are managed by the government. The government must recapitalise them to keep them in business. To do this, it has no option but use taxpayers’ money to improve the financial health of these banks so that they can carry out the function of advancing and financing economic activity. Therefore, talk of establishing a “bad bank” gained momentum.

So, what is a bad bank? It is an organisation that acquires all the NPAs of a bank at a price that is below its book price. It then works to recuperate and turn around the assets by way of expert management, sale or restructuring. The sellers of these bad credits can clear their balance sheets and hold only the good assets after cancelling the bad ones. The main advantage of forming a bad bank is asset monetisation. Bad assets will remain the risky zone, while the good ones stay in the other category. With this, investors are confident of the bank’s fiscal health and can pour in more funds.

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Initially, NARCL will acquire bad loans from banks and disburse 15% of the decided value in cash and the balance 85% will be in the form of security receipts. When the assets are disposed of by taking help from IDRCL, the banks will be paid back the rest. If the bad bank is incapable of selling the bad loan or has to sell by incurring a loss, then the government guarantee will be evoked and the variance between what the commercial bank was supposed to receive and what the bad bank was able to nurture will be funded from the Rs 30,600 crore that has been offered by the government.

The US, Malaysia, Ireland, Nigeria, Sweden and Finland have used bad banks to put an end to their financial crisis. A noticeable instance of a bad bank is Portugal’s Novo Banco. Novo Banco was started by the government of Portugal in August 2014 as part of a rescue of the dwindling Banco Espirito Santo (BES). BES was split into a “good bank” covering its good assets and a “bad bank” (Novo Banco), comprising all the difficult-to-recover loans. Another illustration is Grant Street National Bank. It was established in 1988 to accommodate the bad assets of Mellon Bank.

In January 2017, the idea of setting up a “bad bank” attained popularity in India when RBI deputy governor Viral Acharya recommended two models—Private Asset Management Company and National Asset Management Company (NAMC) to resolve the concerns of strained assets.

Now the question is whether a bad bank will help to solve the mega problem of NPAs? From the viewpoint of a bank burdened with extreme NPA levels, it will help. The bad bank will assist the banks to erase all its lethal assets which were damaging their profitability in one quick attempt. Additionally, the bank’s position will develop when the recovery money is paid back. NARCL will be assessed on how rapidly and how efficiently it can settle the stressed assets it takes over. That will depend on what type of conditions it is capable of providing to the banks whose NPAs it is procuring.

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However, from the viewpoint of the government and the taxpayer, the scenario is more confused because whether it is recapitalising PSBs loaded with bad loans or providing guarantees for security receipts, the funds come from the taxpayers’ pocket. Although such actions of the government are habitually termed as “reforms”, they are band aid at best. The only justifiable remedy is to develop the advancing operation in PSBs. Importantly, the strategy of bailing out banks will crumble if the bad bank cannot sell such diminished assets in the market. If that occurs, guess who will have to bail out the bad bank itself? Indeed, the taxpayer.

Now a bad bank is the pathway and the fundamental job before the government is to guarantee that it attains a reasonable level of success in accomplishing the duty allocated to it. If a bad bank turns out to be a problematic establishment that is incapable to preserve a healthy balance between its assets and liabilities, it will be disastrous. The government must implement measures to ensure that the governing system permits a bad bank to carry out its tasks with rapidity and a manageable cost to itself. Then only will the bad bank become a successful venture.

The government has chosen the first move towards this by introducing the Insolvency and Bankruptcy Code (IBC) which aims to resolve the problems of NPAs. Up to now, it has done well, but there are miles to go. The resolution procedures should be condensed and it has to assure that appeals to higher authorities are not employed as an adjourning trick by the accused parties. The government should immediately fill the many vacant positions in tribunals that are the medium for the resolution procedure to be carried out.

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The people who will manage the bad bank should be autonomous experts so that they can perform a good job of locating buyers for strained advances with some logic and not at throwaway prices. The concept of the bad bank should not become a case of old wine in new bottles. It is also crucial that the bank be capable of retrieving the amenities of efficient resolution professionals who are already aiding the IBC process.

As a final point, the government should have a clear notion that a bad bank once established, should not go on endlessly. The global experience is that a bank is established after a financial system becomes laden with NPAs due to remarkable macroeconomic changes, then it does its job with some achievement and subsequently, it is wound up.

Also, the government must alter the manner in which it manages its financial institutions and banks. If huge credits are granted on the basis of phone calls from politicians and civil servants whose gestures senior managers dance to, then there will be no faith.

—The writer is a financial and tax specialist, author and public speaker based in Margao, Goa

Read the related article: What is a bad bank?