bad-bank-to-take-on-npas

Context: The Indian Banks Association(IBA) have requested the central govt to set up a 'bad bank' to reduce the impact of the losses banks will face because of provisioning for NPAs.

Background:

  • SARFAESI Act enables and empowers the secured creditors to take possession of their Securities, to deal with them without the intervention of the court and also alternatively to authorize any Securitization or Reconstruction Company to acquire financial assets of any Bank or Financial Institution (FI). 
  • The Act has been empowered with the overriding effect over the other legislation and it shall be in addition to and not in derogation of certain legislation.
    • Sarfaesi Act allows secured creditors to take possession of the assets of a borrower who fails to pay dues within 60 days of demanding repayment.
  • International experience shows that a ‘bad bank’ or ‘Asset Management Company (AMC)’ has the potential to fulfil the above vital principles and can possibly address the NPA resolution challenge more effectively.
    • The Korea Asset Management Corporation (KAMCO) played a major role in resolving stress in its banking system which was at the heart of the financial crisis that the country faced in 1997-98.
  • The economic survey of 2016-17 pointed out the twin balance sheet problem — stressed companies on one hand and NPA-laden banks on the other — and advocated a centralised Public Sector Asset Rehabilitation Agency (PARA) be established to deal with the bad loans problem.

What’s a bad bank and how it works?

  • A bad bank is a structure that moves the distressed and illiquid assets of a bank into another entity through regulatory structures such as asset reconstruction companies (ARCs), alternative investment funds (AIFs) and asset management companies (AMCs). 
  • Once it is formed, banks divide their assets into two categories (a) one with non-performing assets and other risky liabilities and (b) others with healthy assets, which help banks grow financially.
  • 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. 
  • Setting up an ARC platform :
    • Buy the stressed pools from banks and turn them around. 
    • This would allow banks to write off the appropriate provisions for the portfolio sold and get the discounted value that the ARC pays for the distressed pool purchase. 
    • The stressed assets can alternatively be sold to an AIF, which could turn them around.
    • ARCs will buy those pools of stressed assets only if they see continued viability of those pools being recovered and if they are able to get higher returns than the original purchase price.

Argument against Bad Bank:

  • Reduces transparency: By forcing the government, in its capacity as the owner of multiple banks, to set up a bad bank and buy distressed assets at “book value" is setting up a way to build opaqueness in its dealing with bad loans.
  • Bad precedent: if a bank owner wants to own an ARC and move bad loans from the bank to the ARC, what precedent does that set for other banks and non-banks to also seek an ARC of their own.
  • Capital as biggest challenge: Only few Public Sector banks are allowed to raise capital from the capital market.
  • Most bad loan declarations of late are taking place due to strict regulatory supervision pressures and lenders’ balance sheets are being cleaned out.
  • Turnaround specialists with specific sectoral skills are needed for the task of ARCs, not just experts with credit underwriting or collections expertise.
  • Once the NPA problem is settled, the Bankers may become complacent and again resume reckless lending.

What happens to NPAs if there’s no bad bank?

  • Equity infusion: Lenders would have to pitch for the interest of ARCs in the market to gauge their interest in the distressed pool. They will also have to provide for NPAs in the balance sheets. 
  • Avoid moral hazard: NPA’s  push banks to seek more equity infusion from investors, the government being the majority owner in most cases. This would be a transparent way of telling public investors where their money is going. 

Success of the AMC will depend on three critical conditions:

  • first, there should be a clear distinction between the bad and good assets (in other words, the definition of a bad asset has to be followed strictly.
  • second, over time, the economy should bounce back to high growth trajectory.
  • third, preventive measures must be in place so that every new loan that is disbursed does not become an NPA too soon.

Project Sashakt

The panel under the chairmanship of PNB non-executive chairman Sunil Mehta has recommended a five pronged approach in Project “Sashakt” .

  • Bad loans of up to ₹ 50 crore will be managed at the bank level, with a deadline of 90 days.
  • For bad loans of ₹ 50-500 crore, banks will enter an inter-creditor agreement, authorizing the lead bank to implement a resolution plan in 180 days, or refer the asset to NCLT.
  • For loans above ₹ 500 crore, the panel recom­mended an independent AMC(Asset Management Company), supported by institutional funding through the AIF.
  • According to the Sunil Mehta committee, banks will have to set up an AMC under which there will be multiple sector-specific AIFs.
  • These funds will invest in the stressed assets bought by existing (Asset Reconstruction Companies) ARCs, such as ARCIL.
  • The ARCs will use the Alternative Investment Funds (AIFs) to redeem security receipts issued to banks against the bad loans.

NPA-Non Performing asset

  • NPAs can be classified as a substandard asset, doubtful asset, or loss asset, depending on the length of time overdue and probability of repayment.
  • A non performing asset (NPA) is a loan or advance for which the principal or interest payment remained overdue for a period of 90 days.
  • Substandard assets: Assets which have remained NPA for a period less than or equal to 12 months.
  • Doubtful assets: An asset would be classified as doubtful if it has remained in the substandard category for a period of 12 months.
  • Loss assets: As per RBI, “Loss asset is considered uncollectible and of such little value that its continuance as a bankable asset is not warranted, although there may be some salvage or recovery value.”


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