RBI Approval Pending for the Bad Bank

RBI approval pending for the bad bank

Why in news:

• The Reserve Bank of India’s (RBI’s)approval for the implementation of the proposal for setting up a ‘Bad Bank’ is still pending.
• Six months after the setting up of the National Asset Resolution Company Limited(NARCL), the proposal for setting up a ‘bad bank’ — a key reform measure of this fiscal year’s Budget — is yet to take off.
• The impediments include issues arising from the ownership structure and operational mechanism, with the proposed setting up of two separate entities — the NARCL and the India Debt Resolution Company Limited (IDRCL).
• The RBI has now indicated that both the acquisition and resolution should be housed under the same legal entity. Accordingly, the NARCL and the IDRCL are reworking the arrangement under which both the processes will be under the former’s control.

Accordingly, the NARCL and the IDRCL are reworking the arrangement under which both the processes will be under the former’s control.

The NARCL has been set up and issued a licence by the RBI to conduct business as an Asset Reconstruction Company.

Simultaneously, a separate company has been set up to function as an Asset Management Company, named IDRCL, which will provide management and resolution of assets and also help in the operational aspects, relating to price discovery and aim at evolving the best possible recovery and the resolution process.

What is bad bank:

• When the borrowers of a bank start defaulting on their payments recurrently, the loans are categorised as ‘bad debts’. And when these bad debts spike beyond manageable limits, a separate bank might have to be created to look after them collectively. That new bank is called a bad bank.
• A bad bank(also referred to as an asset management company or AMC) is a corporate structure which isolates illiquid and high risk assets (typically non-performing loans) held by a bank or a financial organisation, or perhaps a group of banks or financial organisations.
• A bank may accumulate a large portfolio of debts or other financial instruments which unexpectedly become at risk of partial or full default.
• A large volume of non-performing assets usually make it difficult for the bank to raise capital, for example through sales of bonds.
• In these circumstances, the bank may wish to segregate its “good” assets from its “bad” assets through the creation of a bad bank.

How many bad banks are there in India?

• The proceeds from the sales help the banks recoup some of the money they had lent to companies.
• This is not the first time India has faced a bad loan crisis or launched a “bad bank”.
• In fact, there have been 28 such firms, all privately owned, in the past two decades, but recoveries have been underwhelming.

About NARCL:

• The NARCL is majorly owned by public sector banks with 51 per cent ownership but in the case of the IDRCL, 51 per cent shares are in private hands.
• Normally, a single entity to be held accountable as owner, and for recovery of the assets, is the practice followed across geographies. Possibly a ‘Principal and Agent mechanism’ or similar arrangement may evolve to resolve this issue.
• The Indian Banks’ Association is learnt to have wanted to a dual structure, with the AMC as a privately held entity, to be out of the purview of the regulatory entities.
• However, the RBI is yet to agree to this dual structure. “An early decision in the matter is expected and shall be welcome considering the crucial role of the proposed bad bank,” said a banking source.
• A senior government official said the government expects this issue to be resolved soon and the first batch of resolutions should kick in before March-end.
• The first batch of Rs 90,000-crore NPAs were supposed to be acquired by the NARCL in January.
• Dual structure has been common in the capital market where Sebi is the regulator, and this is the best possible solution. The RBI will see how best to regulate it.

Background:

• As a proactive and sustainable solution deal with NPAs in the banking sector, the Finance Minister had, in this year’s Union Budget, announced setting up the NARCL to take over stressed debt of banks and manage these in a market-led way.
• “The intent was to acquire large value non-performing assets (NPAs) from banks and put them under the ownership of an entity that will take suitable steps to affect recovery/resolution. This would in turn also help the banks to concentrate and focus on their primary functioning of fresh landing. Takeover of assets worth Rs 2 lakh crore was envisaged in a phased manner.
• With a combination of post-Covid moratorium and recoveries, there was an actual decline in NPAs from Rs 8.4 lakh crore in 2020 to Rs 7.8 lakh crore in 2021. “However, the pandemic has adversely impacted some sectors like tourism, aviation, entertainment and private employment/wages. The retail NPAs are, thus, expected to go up besides the worst affected sectors, which may require a special package for revival
• The government approved a 5-year guarantee of up to Rs 30,600 crore for security receipts to be issued by the NARCL as non-cash consideration on the transfer of NPAs. This will address banks and RBI concerns about incremental provisioning, said an analyst.

What is National Asset Reconstruction Company Limited (NARCL)? Who has set it up?

• NARCL has been incorporated under the Companies Act and has applied to Reserve Bank of India for license as an Asset Reconstruction Company (ARC).
• NARCL has been set up by banks to aggregate and consolidate stressed assets for their subsequent resolution. PSBs will maintain51% ownership inNARCL.

What is India Debt Resolution Company Ltd. (IDRCL)? Who has set it up?

• IDRCL is a service company/operational entity which will manage the asset and engage market professionals and turnaround experts. Public Sector Banks (PSBs) and Public FIs will hold a maximum of 49% stake and the rest will be with private sector lenders.

Why is NARCL-IDRCL type structure needed when there are 28 existing ARCs?

• Existing ARCs have been helpful in resolution of stressed assets especially for smaller value loans. Various available resolution mechanisms, including IBC have proved to be useful.
• However,considering the large stock of legacy NPAs, additional options/alternatives are needed and the NARCL-IRDCL structure announced in the Union Budget is this initiative.

Why is a Government Guarantee needed?

• Resolution mechanisms of this nature which deal with a backlog of NPAs typically require a backstop from Government.
• This imparts credibility and provides for contingency buffers. Hence, GoI Guarantee of up to Rs 30,600 crore will back Security Receipts (SRs) issued by NARCL.
• The guarantee will be valid for 5 years. The condition precedent for invocation of guarantee would be resolution or liquidation.
• The guarantee shall cover the shortfall between the face value of the SR and the actual realisation. GoI’s guarantee will also enhance liquidity of SRs as such SRs are tradable.

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.

What benefit do banks get from this new structure?

• It will incentivize quicker action on resolving stressed assets thereby helping in better value realization.
• This approach will also permit freeing up of personnel in banks to focus on increasing business and credit growth.
• 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.