Yesterday the union cabinet approved the setting up of the National Asset Reconstruction Company (NARCL) with the objecting of cleaning the banking sector of bad loans. This institution has been dubbed as ‘Bad Bank’, because it will take over bad debt of nearly Rs 2 lakh crore from banks, cleaning the books of the banks. This is now this ‘Bad Bank’ is intended to work in simple terms.
The NARCL will essentially take over bad loans, loans that are not being repaid by the borrowers, giving relief to the banks and freeing them from the hassles of recovering unpaid loans.
Banks accept deposits and pay interest on such deposits, while they earn interest on loans they provide. This is how the banking system works in simple terms, which runs smoothly if the loans and their interests are paid on time by the borrowers. But problems start when some borrowers don’t pay their due interest and principal amounts to the banks for various reasons. As per current rules, when a loan is not repaid within 90 days of the due date, they are termed as non-performing asset. Rising NPA means decreasing earning of a bank.
Asset Reconstruction Company
Asset Reconstruction Companies step in to take over bad loans from banks, there are several private ARCs in India. Generally, ARCs buy NPAs at steep discounts, which means banks have to accept big cuts in the loan size, and the ARCs are not able to buy big assets. NARCL will be a public sector ARC, with deep pockets to buy big bad loans. It is expected that being a public sector company, NARCL will not demand big discounts from the banks.
At present there are 28 ARCs, however, the NARCL will not compete with them. The new company will only focus on big NPAs worth around ₹2 lakh crore, while the rest ₹6 lakh crore NPA will remain available for the existing ARCs to tackle.
NARCL and IDRCL
NARCL will pick up bad loans above a certain threshold from banks, and it will then aim to sell those loans to prospective buyers who deal in distressed debt. The company will also be responsible for the valuation of bad loans to determine the price at which they will be sold. According to the Finance Ministry, the company will acquire the debts by paying 15% cash and 85% Security Receipts (SRs) to the banks.
To acquire bad loans from the banks, the cabinet yesterday also approved Central Govt guarantee of Rs 30,600 crore to back Security Receipts issued by the NARCL. However, the union govt will not own the institue, its 51% share will be owned by public sector banks, while the rest 49% will be held by Financial Institutions or debt management companies.
NARCL will raise capital through equity from banks and Non-Banking Financial Companies (NBFCs). The company will also raise debt when required.
NARCL will not work alone, the government will set up another organisation to work along with it, the India Debt Resolution Company Ltd (IDRCL). The IDRCL will be a service company or operational entity, which will manage the assets acquired by NARCL. It will enrol market professionals and turnaround experts in managing the bad assets in an attempt to turn them around. Public Sector Banks (PSBs) and Public FIs will hold a maximum of 49% stake in IDRCL, and the rest will be held by private-sector lenders.
NARCL will acquire stressed assets from the banks by making an offer to the lead bank in the debt. Once the offer is accepted and NARCL acquires the bad loan, IDRCL will take over the tasks of management and value additions of such loans.
Benefits for banks
The NARCL-IDRCL combine will incentivize quicker action on resolving stressed assets, and thus they will help in better value realization of loans. After bad loans are acquired by NARCL from the banks, the banks will be able to concentrate on their core activities and growth of their business, instead of running behind the bad loans. After the NPAs are removed from their books, the valuation of banks will improve and this will increase their ability to raise market capital.
Why Now
While the country already has several mechanisms for recovering bad debt, the need to set up NARCL-IDRCL was felt. At present, the Insolvency and Bankruptcy Code (IBC), the Securitization and Reconstruction of Financial Assets and Enforcement of Securities Interest Act (SARFAESI Act) and Debt Recovery Tribunals, along with dedicated Stressed Asset Management Verticals (SAMVs) in banks have improved NPA scenario substantially.
But despite these efforts, a substantial amount of NPAs continue on the balance sheets of banks. The bad loans revealed by the Asset Quality Review are not only large but also fragmented across various lenders. Moreover, the existing ARCs are not able to acquire big size bad loans from the banks due to their financial limitations.
In addition to that, high levels of provisioning by banks against legacy NPAs has presented a unique opportunity for faster resolution.
The Government Guarantee
The union govt has made a provision of govt guarantee for acquired bad loans, and allocated Rs 30,600 crore towards it. In case there is a shortfall in the amount realised from the underlying assets and the face value of SRs issued for that asset, the government guarantee will be invoked. The guarantee will be valid for 5 years, subject to an overall ceiling of ₹30,600 crore.
The guarantee will be applicable only when there is a resolution or liquidation of the assets. Further, to disincentivize delay in resolution, NARCL has to pay a Guarantee fee, which will gradually increase with passage of time.
Resolution of assets
NARCL is intended to resolve stressed loan assets above ₹500 crore each amounting to about ₹2 lakh crore in total. The company will acquire stressed assets by paying 15% of the agreed value of the asset in cash, and will issue security receipts (SRs) for the rest 85% value. The security receipts are essentially tradable debt instruments.
In phase I, fully provisioned assets of about ₹90,000 crores are expected to be transferred to NARCL, while the remaining assets with lower provisions would be transferred to the company in phase II. Fully provisioned assets mean the loans have been written off by the banks, and new capital brought it. This will mean that the price paid by the NARCL for acquisition of such assets will directly go to the bottomline of the banks, resulting in increase in profitability of the banks.
NARCL will have five years to resolve the loans, giving ample time to turn bad loans into good. This will avoid panic sale and liquidation done by banks at heavily discounted rates at present to get rid of bad loans. IDRCL will be able to employ experts and professional management teams to run stressed companies, turn them around and sell them at a profit.
