Explained: India's bad banks to clean NPAs from bank balance sheet

NARCL has been set up by banks to aggregate and consolidate stressed assets for their subsequent resolution. Public sector banks will have majority ownership at 51% in the new company, writes ETV Bharat's Krishnanand Tripathi.

New Delhi: The Union Cabinet chaired by Prime Minister Narendra Modi Wednesday approved a Rs 30,600 crore for bank security receipts to be issued by a newly set up specialised institution for acquiring bad loans.

In her budget speech in February this year, Finance Minister Nirmala Sitharaman had announced the government's intent to set up a specialised institution to aggregate bad loans, a national asset reconstruction company, popularly known as a bad bank as it will acquire non-performing assets (NPAs) or bad loans of banks.

Debasish Panda, Banking and Financial Services Secretary, Thursday told the reporters that the NARCL has already been incorporated. NARCL proposes to acquire stressed assets of about Rs 2 Lakh crore in a phased manner under the existing guidelines of the Reserve Bank of India.

It intends to acquire these bad loans through 15% Cash and 85% in Security Receipts (SRs).

Problem of legacy NPAs

According to the latest official data shared by the government in Parliament in July this year, the gross non-performing assets or bad loans of public sector banks increased from Rs 2.17 lakh crore in March 2014 to Rs 8.96 lakh crore in March 2018, within the first four years of Prime Minister Narendra Modi's term.

The government said it was due to transparent recognition NPAs and since then the NPAs of public sector banks have declined due to the four-pronged strategy adopted by the government which involves recognition, resolution, recapitalisation and reform.

As per the latest provisional data, the gross NPAs of government banks declined to Rs 1.97 lakh crore at the end of March this year.

Solution: A national asset reconstruction company (NARCL)

NARCL has been incorporated under the Companies Act and has applied to the Reserve Bank of India for a license as an Asset Reconstruction Company (ARC).

NARCL has been set up by banks to aggregate and consolidate stressed assets for their subsequent resolution. Public sector banks will have majority ownership at 51% in the new company.

India Debt Resolution Company Limited (IDRCL)

In addition to setting up a separate asset reconstruction company – NARCL, the government has also set up a separate debt resolution company called India Debt Resolution Company Limited (IDRCL).

It is a service company that will manage the asset and engage market professionals and turnaround experts. Unlike, NARCL where public sector banks hold a majority stake, government banks and financial institutions will hold a minority stake in this company. Their sharehold has been capped at 49% while the rest will be with private sector banks and financial institutions.

Why Govt created NARCL and IDRCL?

It's a natural question that one should ask as there are already more than two dozen private asset reconstruction companies. However, these 28 private ARCs were not able to take up bad loans of large value.

These companies hesitated in acquiring those bad loans where the outstanding amount may run into tens of thousands of crore or even more. Also, in order to solve the problem of legacy NPAs, an alternative mechanism was needed to handle large non-performing assets.

Finance minister Nirmala Sitharaman said the government decided to set up a national asset reconstruction company as private reconstruction firms hesitated to come out with that kind of number.

Why was sovereign guarantee needed?

Given the huge amount of non-performing assets of public sector banks, the view within the government was that a resolution mechanism of this nature to deal with legacy bad loans required a backstop or support from the government.

“This imparts credibility and provides for contingency buffers. Hence, the Government of India Guarantee of up to Rs 30,600 crore will back Security Receipts (SRs) issued by NARCL.

The guarantee will be valid for 5 years. However, this guarantee can only be invoked in two situations when there is a resolution or liquidation of stressed asset.

The guarantee will cover the shortfall between the face value of the stressed asset and the actual realisation.

How will NARCL and IDRCL work?

The NARCL will acquire assets by making an offer to the lead bank. Once NARCL’s offer is accepted, then, IDRCL will be engaged for management and value addition.

The benefits to the banks

The new mechanism will incentivize quicker action on resolving stressed assets thereby helping in better value realization.

Also, this approach will permit freeing up of personnel in banks to focus on increasing business and credit growth as India Debt Resolution Company will have specialised manpower, professionals to handle the disposal of the stressed assets.

As the holders of these stressed assets and SRs, banks will receive the gains. Further, it will bring about improvement in bank’s valuation and enhance their ability to raise market capital.

Why now?

According to officials, the Insolvency and Bankruptcy Code (IBC), strengthening of Securitization and Reconstruction of Financial Assets and Enforcement of Securities Interest (SARFAESI Act) and Debt Recovery Tribunals, and several other steps were taken by the government brought the focus on recovery but despite all these measures a substantial amount of NPAs remained on the balance sheet of banks.

They say the stock of bad loans as revealed by the Asset Quality Review (AQR) initiated during the tenure of former RBI governor Raghuram Rajan was not only huge but it was also fragmented across various lenders.

High levels of provisioning by banks against legacy NPAs has presented a unique opportunity for faster resolution therefore the government decided to set up NARCL and IDRCL.

Is the guarantee likely to be invoked?

According to officials, the government guarantee will only be invoked to cover the shortfall between the amount realised from the underlying assets and the face value of the security receipts (SRs) issued for that asset, subject to an overall ceiling of Rs 30,600 crore which will be valid for 5 years.

Officials say since there shall be a pool of assets, it is reasonable to expect that realisation in many of them will be more than the acquisition cost.

Faster and timely resolution

The government guarantee will be valid for five years and it can only be invoked when there is a resolution or liquidation. Secondly, to disincentivize any delays in the resolution process, NARCL will be made to pay a guarantee fee which will increase with the passage of time. It will disincentive the delay and encourage a timely and faster resolution of bad loans.

NARCL’s plan to resolve bad loans

The NARCL will resolve stressed loan assets that are above Rs 500 crore in a phased manner with the total value of stressed assets at Rs 2 lakh crore.

In the first phase, fully provisioned assets of about Rs. 90,000 crores are expected to be transferred to NARCL, while the remaining assets with lower provisions would be transferred in the second phase.