{"id":329125,"date":"2024-01-17T17:10:56","date_gmt":"2024-01-17T11:40:56","guid":{"rendered":"https:\/\/www.indialegallive.com\/?p=329125"},"modified":"2024-01-17T18:54:13","modified_gmt":"2024-01-17T13:24:13","slug":"will-bad-banks-solve-the-npa-problem","status":"publish","type":"post","link":"https:\/\/www.indialegallive.com\/laws-research-indepth\/will-bad-banks-solve-the-npa-problem\/","title":{"rendered":"Will bad banks solve the NPA problem?"},"content":{"rendered":"\n

By Amulya Batni<\/strong><\/p>\n\n\n\n

The RBI\u2019s recent announcement about the introduction of a bad bank is the result of resolution of non-performing assets has resulted in multiple elaborate doubts on its effects on the Indian economy. <\/p>\n\n\n\n

Asset Reconstruction companies (ARCs) commonly called bad banks, are regulated under the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act 2002 requirement. The SARFAESI Act (2002) defined asset reconstruction as\u201cacquisition by any asset reconstruction company of any right or interest of any bank or financial institution in any financial assistance for the purpose of realisation of such financial assistance\u201d and \u201casset reconstruction company means a company registered with Reserve Bank under section 3 for the purposes of carrying the business of asset reconstruction or securitisation, or both\u201d. The Narasimham Committee (1998) had imagined a single ARC as a bad bank. But, the SARFAESI Act, 2002 created multiple, privately owned ARCs.(Yadav, 2021). Even though regulations treat ARCs like bad banks, there is a slight difference in their working.  ARCs buy the stressed assets from the bank at a great discounted price whereas Bad banks get the stressed assets transferred from bank which are further managed by them. The concept of Bad banks came to existence in the year 1980 during the time of the financial crisis in the US. All of the defaulted loans made by Savings & Loan banks were handled by the Resolution Trust Company in the US. Following the “Global Financial Problem of 2008,” economists pushed for globally coordinated action to address the crisis facing the global financial system, giving rise to the concept of “bad banks” (Bhagwati et al., 2017)  This paper tries to give an overview about the formation of Bad banks and Asset reconstruction Companies and its need in the Indian economy along with the failure of the IBC and its impact.<\/p>\n\n\n\n

In the budget for 2021\u201322, the finance minister announced plans to establish “bad banks” that would acquire all stressed nonperforming assets held by banks with a guarantee good for five years. Basedon a certain valuation, banks will receive 15% in cash, while the remaining 85% will be provided as Security Receipts. Government must provide a backstop plan in order for Security Receipts to retain their value; for this reason, the Union Cabinet approved government guarantee of Rs 30,600 crore. <\/p>\n\n\n\n

First, we must understand how this model will work and what is at stake for every party of this model. (i) Motivation for Banks –  Over longer time horizons by selling their NPA, bank balance sheets would recover. In many case, if banks hold on to stressed assets this will get reflected in their numbers on headline gross non-performing loans. Another incentive for banks to adopt this strategy could be interaction with specialised ARC officers that will help in the recovery process. With this, banks can focus on their main objective that is providing loans and carry out other important activities instead of focusing on recovering money which involves a lot of time. (ii) Government –  Large amount of NPA\u2019s is owned by public sector banks and hence the government had to introduce fresh capital to maintain the PSBs . This meant that money for other schemes would reduce. Now the government need not be the sole saviour of PSBs (Times of India, 2021). Along with these benefits it\u2019s easier to have one common organisation dealing with this rather than having the same department in multiple banks resolving the same issue. With expertise on board, resolving the issue becomes easier.<\/p>\n\n\n\n

Yet there are some drawbacks to the introduction of Bad banks. This can be analysed using China\u2019s economy. Research conducted by Ben Charoenwong at the National University of Singapore and others stated that bad banks just help in concealing the problems of NPA instead of actually solving them. They observed that 70 per cent of the NPL are resold by the bad banks at inflated prices to third parties. But these third party usually turn out to be borrowers of the same bank. Thus just hiding the  bad loans instead of resolving them (Datta, 2021). Sch\u00e4fer and Zimmermann have identified the need for huge capital to be one of the drawbacks. Shortage of capital crisis is seen with the private ARCs but the National Asset Reconstruction Company might be at a better position but contribution that is to be made by each bank is still unclear. <\/p>\n\n\n\n

The Government in India is not expected to make contributions hence raising huge capital will be difficult thus the NARCL must look at other options such as the RBI (Yadav, 2021). There could be lack of buyers for the toxic asset and the expected price might not be retrieved. India\u2019s legal system can also act as a drawback. The long pending cases and the amount of time that must be invested for the case to be decided can slow down the process of reviving money by the bad banks.Acts like the Securitization and Reconstruction of Financial Assets and Enforcement of Securities Interest (SARFAESI) Act and the Debt Recovery Tribunal (DRT) Act were meant to reduce delays in disputes but unfortunately there was no exceptional results that were noticed. For instance, as of end-2015 about 70,000 appeals were pending with DRTs. There are 33 DRTs and 5 DRT Appellate Tribunals and in the usual course it would take decades to clear the backlog (Bhagwati et al., 2017).<\/p>\n\n\n\n

Process and limitations of IBC<\/h2>\n\n\n\n

The Insolvency Bankruptcy Code is a comprehensive act for solving the conflict between the creditors and debtors and is based on four pillars the – Insolvency and Bankruptcy Board of India, insolvency professionals, adjudicating authorities (Debt Recovery Tribunal (DRT) and National Company Law Tribunal) and information utilities for the speedy and transparent resolution (Yadav, 2021). This act has not been utilised to its full capacity which is one of the reasons for the emergence of bad banks and ARC\u2019s. Under the IBC both the creditors and debtors can appeal for resolution. Once this is accepted the insolvency professionals administers this process where the creditors take over the assets of the debtors.Further acommittee of creditors is constituted that decides the future of the outstanding debt. The committee may decide to modify the debt’s conditions or try to recover some portion by selling the debtor’s assets. The Board of Directors and the promoters lose control over the management and become suspended after the Corporation Insolvency Resolution process is started. The period for the completion of this application process shall last for 180 days. In case of liquidation, the insolvency professional decides to sell the debtor\u2019s assets and recover the best possible price. The sale proceeds of the assets are distributed in the following order: (bsfi, 2020)<\/p>\n\n\n\n