Bad Bank: A cure for Indian Banking Industry?

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A bad bank is proposed on the 2021 union budget by Finance Minister Nirmala Sitharaman. A bad bank is a financial institution commonly called an asset management company or AMC which takes over illiquid or high-risk assets of a financial institution or group of financial institutions. The bad bank has proposed to clear the mounting of NPAs accounts in the books of public sector banks, especially at the time of the covid-19 crisis. The proposed bad bank is named as National Asset Reconstruction Company (NARCL) and is expected to be operational in June 2021.

The promoters of the bad bank will be power finance companies and the PSU banks will hold the rest of the equity stake in ARC. Recently, it is reported that PSU banks have decided to transfer 28 loan accounts to the bad bank i.e., an amount of Rs 82,500 crore of advances due, and in addition also transfer AUM above Rs 2 lakh crore. Some of the borrowers are Amtek Auto, Reliance Naval, Videocon Oil Ventures Limited (VOVL), Castex Technologies, Lavasa Corporation, Ruchi Worldwide, Visa Steel, Consolidated Construction.

The usual rates for NPAs at the time of purchasing by an ARC are priced at 30-40% of the principal amount. It is heard that the NARCL would acquire loans at the current book value. The payment will be 15% in cash and the balance will be in security receipts or any other form at their discretion. The government will guarantee the security receipts issued by the NARCL.  

Some of the advantages of the proposed Bad Bank structure are it will clear the NPAs mounted in the bank’s balance sheet, provide quick relief to the banking system, capital inflow to banks, and enables the provision of fresh credits, etc. On the contrary, cons include actual recovery value of these loans may get reduced which led to erosion of capital to NARCL, results in aggressive granting of fresh credits, transfer of loan will be on current date whereas recovery happens only in future, etc.

The bad bank will not help losses to disappear instead allows speedy recovery of loans in the future. NARCL should have the expertise for interim crisis management of in the companies such as cost reduction, restructuring, selling off surplus assets to generate liquidity, etc.  NARCL should require specialized knowledge in different sectors to manage its day-to-day operations. It should be ensured that provisioning policies of the bad bank will be following the term /maturity of the SRs issued. Also, it would be a difficult task for the NARCL to save taxpayers money in the medium and long term.

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