The doctors who treat the insane are not insane themselves; neither are crime branch police personnel criminals, though they are at times called ‘mental doctors’ and ‘crime police’ respectively. Thus, a bad bank, which is supposed to deal with the bad loans is, prima facie, a good bank. But, how good, or bad, will our new bad bank, which is going to take off soon, be?
The esoteric explanations of the experts in government and banking sectors are unintelligible to a lay mind while the policy decision squarely impacts the laity. So, dumbing down the bad bank’s character will greatly help know the truth and judge its utility or futility. To deal with the huge pileup of banks’ bad loans ~ the nonperforming assets (NPAs) ~ and thereby to cleanse the banks’ balance sheets, the government, as per its 2021-22 budget announcement, got a bad bank, the National Asset Reconstruction Company Limited (NARCL) incorporated under the Companies Act on 7 July 2021.
Public sector banks will hold 51 per cent of this bank’s capital, making it a public sector concern; the RBI granted a license to it as an Asset Reconstruction Company (ARC) on October 4. In tandem, came the India Debt Resolution Co Ltd (IDRCL) as an Asset Management Company (AMC) with private-sector lenders holding 51 per cent of shares. While the public sector ARC acquires the bad loans (slated to acquire Rs.2 lac crore NPAs initially) the private sector AMC resolves/manages them. The NARCL and IDRCL combination is known as a bad bank.
The public sector banking circles seem to be unhappy with the private sector dominance of IRDCL while RBI is understood to be not enthusiastic about the dual structure; so, some changes in the arrangements are likely. The mechanism of the bank for simple understanding will be something like this: banks transfer their NPAs to the bad bank in return for whatever money they get from and thereby increase their standard assets, good loans. One example to make the point clearer: ABC Bank gives a loan of Rs 1,000 crore to DEF company. DEF fails to repay, and ABC loses all its hopes of recovery. Instead of keeping the outstanding loan idly on its books, ABC transfers the loan to the bad bank. In return, the bad bank pays some 15 per cent of the loan value, Rs 150 crore in the given example. It seeks to recover to the maximum extent possible from DEF and resolve the debt. That Rs 150 crore too, is a satisfactory sum or an unexpected profit to ABC since it lost all hopes of recovery from DEF.
Add to that, a low or no NPA situation helps ABC to boost its sound health to gain the confidence of stakeholders. Needless to add, the mounting bank NPAs have disastrous consequences for the economy as a whole besides the damage they cause to the bank’s stakeholders ~ the depositors and other customers and shareholders.
The NPA pile-up estimate in the banks as of March 2021 was Rs 8.35 lac crore; of it, 77.9 per cent belonged to big borrowers. A further rise in NPAs to Rs 11 lac crore by March 2022 is forecast. The RBI’s Financial Stability Report of July 2021 put the Gross NPAs of Scheduled Commercial Banks put at 7.48 per cent in March 2021 and 9.80 per cent by March 2022 under the baseline scenario and at 11.22 per cent under a severe stress scenario. Indications suggest an increasing trend of bad loans; therefore, the increased need to reduce them even through the bad bank mechanism when recovery efforts through the normal course fail.
The bad banks’ idea is not new to the financial world. The Mellon Bank of the US set up the first-ever bad bank, the Grant Street National Bank, in 1988, to hold $ 1.4 billion of its bad loans. The 2007-10 financial crisis in the developed world triggered the bad banks’ spurt. Several countries including Sweden, Finland, Indonesia, Ireland, Belgium have experimented with bad banks. In India, too, the bad banks’ idea and ARCs are not new.
Several Expert Committees including the Narasimham Committee of 1991 and 1998 and the Andhyarujina Committee of 1999 have directly or indirectly recommended setting up ARCs for hiving off bank bad loans to them. The first ARC, Asset Reconstruction Company (India) Limited got an RBI license in 2004. India now has 28 ARCs; they are not bad banks in a strict sense although they buy bad loans and their cumulative Assets Under Management (AUM) stood at about Rs 5.2 lakh crore (book value) by March 2021.
The ARCs’ performance has not been encouraging (RBI’s Committee on ARCs September 2021); the lenders could recover only 14.29 per cent of their outstanding bad loans transferred to ARCs from 2004 to 2013 and their recovery method did not facilitate the business revival of the borrowers to an overwhelming extent of 80 per cent as per the RBI report. Before the ARCs, the government experimented with several measures to deal with bank NPAs. It brought in SICA (Sick Industrial Companies (Special Provisions) Act, 1985) and aimed at resolving the insolvency of sick units through the Board for Industrial and Financial Reconstruction (BIFR), an experts’ group. But the measure was a failure and had to be repealed in 2003.
Some of its provisions were added in the Companies Act, 2013; the National Company Law Tribunal (NCLT) took over the BIFR’s functions. Later, the Insolvency and Bankruptcy Code, 2016 (IBC) was set up. the Recovery of Debt due to Banks and Financial Institutions Act, 1993 (RDDBFI Act) and the Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest (SARFAESI) Act, 2002 were the other legislations. The RDDBFI facilitated the Debt Recovery Tribunals (DRTs) while the SARFAESI Act allows secured creditors to enforce their security interest without the intervention of courts. It is this same that provides for the creation of ARCs, an institutional arrangement to handle bad loans.
It is because of the failure of these steps that the bad loans problem lingers and therefore another experiment, the bad bank’s birth. That the banks are not going to benefit much is evident in the earmarking of the funds: the government is giving Rs.30,600 crore worth Security Receipts (SRs) a guarantee to pay to the banks in case the bad bank, the NARCL, fails to pay the agreed dues withing five years. In addition, NARCL makes an upfront payment of Rs 5,400 crore. These sums add up to Rs.36,000 crore which equals 18 per cent of Rs 2,00,000 crore which means banks will have a haircut of 82 per cent.
The bank trade unions and other critics say, with evidence that is difficult to deny, that the bad bank is going to be one more route to help corporate and other big loan evaders. The course involves a corporate entity borrowing money from the bank, then becoming insolvent after some time and defaulting on the loan, leading the bank to sell the assets dirt cheap to another corporation through the IBC route. Economist C P Chandrasekhar gave the example of Videocon Industries’ Rs 35,000 crore loan outstanding, (Rs 64,938 crore when other claims included) resolved before the NCLT at just Rs 2,962 crore. Thus, the lenders agreed to take a 95.85 per cent “hair cut”.
Bank Employees Federation of India says that the Bad Bank (NARCL), is for the resolution of large loan defaults of private corporate houses. It points to the Rs 10.83 lac crore worth corporate loan write-off during the past five years which fact the government doesn’t mention while boasting of Rs 5 lac crore recovery over the same period. Through the Insolvency and Bankruptcy Code mechanism, 396 cases of claims amounting to Rs 6.82 lakh crore were resolved till June and only about Rs 2.45 lakh crore was recovered out of that sum. So, the write-off was a staggering 64 per cent of total claims.
Of late, a major state-owned lender has alleged “gross irregularities” by resolution professionals who had proposed a 95 per cent haircut to financial creditors, offering Rs 385 crore for admitted claims of Rs 7,807 crore in the Jet Airways resolution.
The K V Kamath Committee, which helped the RBI with designing a one-time restructuring scheme, had also noted that corporate sector debt of Rs 15.52 lakh crore has come under stress after Covid-19 hit India, while another Rs 22.20 lakh crore was already under stress before the pandemic. This effectively means Rs 37.72 lac crore (72 per cent of the banking sector debt to industry) remains under stress. This is almost 37 per cent of the total non-food bank credit. That shows the magnitude of corporate default; employees’ organizations’ data cannot be poohpoohed for the simple reason they are bank insiders, although they are not responsible for these big loan sanctions and their eventual write-offs.
But why the huge pile of bad debts and their increase and why are banks not able to recover them in the normal course? Is it because the lending itself was bad where the wrong borrowers were accommodated, and inadequate collateral was taken to safeguard the bank’s interest? Whatever the reason, public money ~ deposits in the banks belong to the people ~ has been recklessly lent. The measures that have been initiated did not ensure recovery but resulted in huge haircuts by banks. The latest government-supported bad bank, too, is unlikely to recover more money from the defaulters than the previous arrangement because the lending and borrowing background is not dissimilar. Ultimately the bad bank may be a good opportunity for loan evaders and for those eager to acquire cheap the units set up with huge borrowing.
(The writer is a development economist and commentator on economic and social affairs)