Bad Bank

WHY IN NEWS

• The Cabinet on 16^th September 2021 cleared a Rs.30,600 crore guarantee programme for securities to be issued by the newly incorporated ‘National Asset Reconstruction Company (NARCL)’ for taking over and resolving non-performing assets (NPAs) amounting to ?2 lakh crore.

WHAT IS NON-PERFORMING ASSETS (NPAs)?

• A Non-Performing Asset (NPA) refers to a classification for loans or advances that are in default or in arrears.
• It is a loan or advance for which the principal or interest payment remained overdue for a period of 90 days.
• While 90 days is the standard, the amount of elapsed time may be shorter or longer depending on the terms and conditions of each individual loan.
• For agricultural loans, if the interest and/or the installment or principal remains overdue for two harvest seasons; it is declared as NPAs. But, this period should not exceed two years. After two years any unpaid loan/installment will be classified as NPA.
• Banks are required to classify NPAs into three:
  • Substandard assets:
    • Assets which has remained NPA for a period less than or equal to 12 months.
  • Doubtful assets:
    • An asset would be classified as doubtful if it has remained in the substandard category for a period of 12 months.
  • Loss assets:
    • Loss asset is considered uncollectible and of such little value that its continuance as a bankable asset is not warranted, although there may be some salvage or recovery value.

INDIA’S NPA SCENARIO::

• Gross NPAs of banks (as a percentage of total loans) have increased from 2.3% of total loans in 2008 to 11.5% in 2017.
• India’s NPA ratio saw a surge in 2016 after the RBI carried out an expansive Asset Quality Review >> The review resulted in identification of many large loan accounts which had gone bad resulting in a huge jump in NPAs in India.
• However, the share of Gross Non-Performing Assets (GNPAs) among total loans declined to 9.1% in FY19 after having risen for seven consecutive years.
• According to the latest figures released by the RBI, the total size of bad loans in the balance sheets of Indian banks at a gross level was just around ?9 lakh crore as of March 31, 2020, down significantly from over ?10 lakh crore two years ago.
• In light of the pandemic, the Financial Stability Report (FSR) of the RBI in July 2020 presented a grim picture of the status of NPAs in India >> It stated that situation posed by COVID-19 could result in the Gross NPAs increasing to 12.5 percent by March 2021 as against 8.5 percent in March 2020.
• As per Standard and Poor's estimates >> Gross NPA could rise to 13-14 percent for India in 2021.
• India’s Non-Performing loans ratio (%) is the worst among emerging economies.

WHAT IS NATIONAL ASSET RECONSTRUCTION COMPANY?

• National Asset Reconstruction Company Ltd (NARCL), the name coined for the bad bank announced in the Budget 2021-22, was incorporated in June 2021, under the Companies Act.
• It has been set up by banks to aggregate and consolidate stressed assets for their subsequent resolution.
• It has an authorised capital of Rs 100 crore.
• Sixteen banks, 12 state-owned and 4 private banks will invest in NARCL. Canara Bank will be sole sponsor of NARL with 12% stake. SBI is going to be second-largest shareholder with 9.9%.
• NARCL proposes to acquire stressed assets of about Rs. 2 Lakh crore in phases within extant regulations of RBI.
• NARCL will pay up to 15 per cent of the agreed value for the loans in cash and the remaining 85 per cent would be government-guaranteed security receipts.

WHAT IS A BAD BANK?

• Technically, a bad bank is an Asset Reconstruction Company (ARC) or an Asset Management Company (AMC) that takes over the bad loans of commercial banks, manages them and finally recovers the money over a period of time.
• The bad bank is not involved in lending and taking deposits, but helps commercial banks clean up their balance sheets and resolve bad loans.
• The takeover of bad loans is normally below the book value of the loan and the bad bank tries to recover as much as possible subsequently.
• US-based Mellon Bank created the first bad bank in 1988, after which the concept has been implemented in other countries including Sweden, Finland, France, Ireland and Germany.
• Bad banks found resonance during the global financial crisis of 2007-09.

ARGUMENTS FAVOURING BAD BANKS:

• Strengthen banks’ lending capacity:
  • Such a mechanism helps a bank segregate its good assets from bad ones, making it easier for it to raise capital by issuing equity or debt or both.
• Specialisation:
  • A bad bank can act as an aggregator of all stressed assets in the system and work towards the resolution of these assets whereas banks can focus on business.
  • By transferring NPAs to a bad bank, lenders can prioritize financing businesses, while letting a specialized institution focus on maximizing loan recovery.
• Reinvigorates investments:
  • The segregation of toxic assets helps generate confidence among potential investors who can then examine the financial health of the lender with greater clarity.
• The COVID-19 crisis:
  • With the pandemic hitting the banking sector, the RBI fears a spike in bad loans in the wake of a six-month moratorium it has announced to tackle the economic slowdown.
  • In this situation, a professionally-run bad bank, funded by the private lenders and supported the government, can be an effective mechanism to deal with the NPAs.
• Limited success of alternatives:
  • Despite a series of measures by the RBI for better recognition and provisioning against NPAs and massive doses of capitalisation of public sector banks by the government, the problem continues in the banking sector.
• Global success stories:
  • Many other countries had set up institutional mechanisms such as the Troubled Asset Relief Programme (TARP) in the US to deal with a problem of stress in the financial system.
• Timely disposal:
  • Bad banks will ensure that the NPAs are cleaned up in a timely manner. Also, the presence of the government means that the process will be more accountable and judicious.
• Reduce unnecessary scrutiny:
  • Bad banks can eliminate the undue scrutiny by the 4Cs - Courts, CVC, CBI, CAG and thereby foster ease of doing business in the country.
• Minimum government, maximum governance:
  • As India seeks the interest of global investors to partner it in its economic growth, the country needs to demonstrate its non-interference-led-markets-philosophy

ARGUMENTS AGAINST BAD BANKS:

• Multiple mechanisms:
  • Presently, there exist several private asset reconstruction firms that buy bad loans at a discount. Also, the Bankruptcy Code, though not perfect, has helped in higher recoveries.
• Initial investments:
  • Large financial resources are essential for buying the NPAs from banks. But India’s corporate bond market is not developed enough to cater to such demands.
• Moral hazard:
  • A government-funded bad bank will allow the reckless lending by banks to continue. There is also the fear that it will end up as another case of throwing public money to fund corporate mismanagement.
• Mere shifting of loans:
  • It is poor governance to move a bad loan from one account to another entity, which is owned by the same bank or the original shareholders.
  • There is no surety that it will improve the situation.

STEPS NEEDED TO CHECK LOAN TURNING BAD:

• Use of technology:
  • Machine Learning (ML), Artificial Intelligence (AI) as well as Big Data and matching provide banks the ability to recognize patterns quickly by analysing vast datasets >> It could help in prevention of NPAs
• Credit Risk Management:
  • Proper credit appraisal of the project, creditworthiness of clients and their skill and experience should be carried out.
• Adequate functional autonomy to banks
  • So that they can ensure that NPAs are kept to a minimum.
  • RBI’s suggestion for reducing shareholding of the government in public sector banks to 26 percent is worth serious deliberations.
  • Political discretion in loan allocations should be discouraged and all efforts should be aimed at curbing cronyism.
• Facilitating smooth entry and exit for firms
  • This would ensure that firms which are tending towards industrial sickness and being non-performing have policy measures to take recourse to and enable them for a smooth exit option
  • Hence saves firms from further debt trap

PRACTICE QUESTION:

Q. How the new bad bank set up by the government helps in resolving NPAs in India?