Tackling the Problem of Bad Loans - Daily Current Affair Article

Despite various attempts to create an efficient framework for resolving bad loans, poor ecosystem and legal delays frustrate many of these initiatives.

Why in News:

  • Over the last five years, considerable progress has been made in resolving and recovering bad debts of banks through Insolvency and Bankruptcy Code (IBC). Despite this, there are still around Rs. 10 lakh crore worth of stressed assets hanging around in the system.
  • The newly-created National Asset Reconstruction Company (NARCL) in the public sector offers hopes for the faster cleanup of lenders’ balance sheets.

Bad Bank

  • A Bad Bank is an Asset Reconstruction Company (ARC).
  • ARC or Bad Bank buys bad loans from the commercial banks at a discount and tries to recover the money from the defaulter by providing a systematic solution over a period of time.
  • It will manage these Non-Performing Assets in suitable ways, some may be liquidated, others may be restructured, etc.
  • The aim of setting up a bad bank is to help ease the burden on banks by taking bad loans off their balance sheets and get them to lend again to customers without constraints.
  • The idea of Bad Bank was implemented in countries like Sweden, Finland, France, Germany, Indonesia etc.

Need for Bad Banks:

  • It can lead to faster aggregation of distressed assets that lie scattered across several lenders.
  • Its securitized receipts (SRs) carry sovereign assurance. This is of particular comfort to PSU banks as price discovery would not be subject to later investigations.
  • It is also expected to free the banks from the tortuous recovery process and afford them more space to focus on much-needed credit expansion.

National Asset Reconstruction Company Ltd (NARCL)-

  • The NARCL (bad bank) has been incorporated under the Companies Act and has applied to the Reserve Bank of India for license as an Asset Reconstruction Company (ARC).
  • State-owned banks will hold 51% stake, while FIs or debt management companies will hold 49%.
  • NARCL will house bad loan accounts of Rs.500 crores and above.
  • Establishing NARCL is part of the government’s efforts to clean up the financial system, which is sitting on one of the biggest piles of bad assets in the world.
  • It is expected that the warehousing of bad loans by NARCL will allow banks to cut losses and renew lending.

India Debt Resolution Company Ltd (IDRCL)

  • The IDRCL is a service company or an The IDRCL is a service company or an operational entity, which will manage asset and loop in market professionals and turnaround experts.

Working of NARCL-IDRCL:

  • The NARCL will first purchase bad loans from banks.
  • It will pay 15% of the agreed price in cash and the remaining 85% will be in the form of “Security Receipts”.
  • When the assets are sold, with the help of IDRCL, the commercial banks will be paid back the rest.
  • If the bad bank is unable to sell the bad loan, or has to sell it at a loss, then the government guarantee will be invoked.
  • The difference between what the commercial bank was supposed to get and what the bad bank was able to raise will be paid from the Rs 30,600 crore that has been provided by the government.

Issues:

  • Public Sector Banks (PSB) Ownership: The biggest problem is that it will be owned largely by public sector banks and have its management drawn mostly from them hence more likely facing similar results. Also, the PSBs will be both shareholders and customers leading to conflict of interest.
  • Price discovery: Price at which NARCL buys the stressed loans from the banks might prove to be challenging, even though the transaction involves the public sector as both buyer and seller.
  • Uncertainty over the Response from the secondary market: Banks though will have the freedom to sell the security receipts. But to what extent a secondary market for such securities evolves is debatable.
  • Deterioration in asset value: Physical assets tend to deteriorate soon. The NPAs that the NARCL will handle are all old, legacy assets and probably there is little residual value left in them.
  • No sunset clause: It is not clear whether the bad bank has a finite end date or not. In other countries, the bad banks typically had a sunset clause and worked with a finite timeline in mind.
  • Speedy Disposal: In fact, the success of bad banks abroad too has depended on speedy disposal instead of trying to manage them until they got the best price.

Way Forward:

  • This is a positive move for the banking sector. The success of the bad bank however will depend on the implementation and management of the transferred NPAs.
  • With the passing of COVID 19 pandemic, consumer demand is picking up. There will be increasing number of brownfield projects which makes this move perfectly timed.

Sources:

General Studies Paper 3
  • Indian Economy & its Issues