Bad bank: Should India have one?

We have 29 ARCs buying bad assets, but the model has not yielded desired results. Meanwhile, developed nations have tasted success with bad banks

Bad bank: Should India have one?

By Deepak Narang

The debate over a ‘bad bank’, keenly discussed in the official circles and the media in FY17, has been in the focus once again after the IBA sent a proposal for establishing a bad bank to the government and RBI. Earlier, RBI toyed with the idea of a private asset management company and a national asset management company for private and public sector banks, respectively.

At present, banks have NPAs of Rs 9.7 lakh crore (as of December 2019) with estimates of fresh slippages of Rs 5.5 lakh crore primarily because of the Covid-19 stress. We have to look for quick solutions. There is added urgency because the government has put on hold, rightly so, fresh reference to the NCLT under the IBC for one year.

A bad bank is established to buy toxic assets from a good bank at a price that is determined by a bad bank. It is controlled by the government, and apart from the government, other private players invest in its equity. It may raise loan from other banks. These transactions happen at arm’s length and a bad bank is managed by professionals with domain knowledge.

In India, a bad bank has not been set up; rather, private asset reconstruction companies (ARCs) have been buying NPAs from various banks—and 29 ARCs are in the business of buying bad assets but the model has not yielded desired results. ARCs act merely as recovery agents because they lack the bandwidth to reconstruct any company under stress which is sold as going concern. The efficacy of the ARC model is under question. The CVC, some time ago, submitted a report to the government after examining cases above Rs 50 crore that were sold to ARCs between 2013-14 and 2017-18 by PSBs. The report mentions that, in at least 48 cases, assets were sold to ARCs below the realisable value of security. Besides the accounts which were sold as going concern, the value of stocks and equipment were not factored in while fixing the reserve price.

This has acted as a dampener and sale to ARCs is few and far between now. Besides, ARCs have recovered roughly 9.5% of the security receipts that they held at the end of FY18. We need to keep in mind that all PSBs have board-approved policy for sale to ARCs and cases of Rs 50 crore should have been placed before the board for sanction/approval.

If the economy has to come back on track, then lending has to resume in a big way. As a rule of thumb, credit growth is roughly 2-2.5 times GDP growth.

Setting up a bad bank, undoubtedly, is a way forward. The case of Jhabua power plant can be examined to understand the desirability of a bad bank. Jhabua Power for resolution of insolvency was under the IBC on account of shortage of working capital. Two bids were received—one from the NTPC, which made the bid for the first time for Rs 1,900 crore at the rate of Rs 3.2 per MW, and another from Adani Power, for Rs 750 crore at Rs 1.25 per MW. Had the NTPC not entered the fray, the plant, in all probability, could have been purchased by Adani Power may be after some increase of price post bargaining.

In this case, not only the price was higher, but profit, if any, will go to government coffers. The cost to the exchequer will, therefore, be either nil or minimal. Such deals may, subsequently, invite wrath of the CVC/CBI. A bad bank can do this work as it will have the bandwidth to deal with such situations and can rope in experts to manage units/plant till it finds a buyer. Besides, it may share future profits with the bank that sold this asset.

Arguments against establishing bad banks are: (1) When there are no takers for bad assets, so why have a bad bank; (2) Why waste government resources when the Covid-19 crisis has put tremendous strain on resources; (3) The price at which toxic assets will be transferred will not be market-determined and price discovery will not happen; (4) ARCs are already there for the purpose.

Let us provide a different perspective to these issues.
1. If there are no takers for the assets, then it makes sense to let domain experts deal with toxic assets till these can be sold.
2. As in the case of Jhabua Power and in most cases of Rs 500 crore and above, the government may suffer minimum loss.
3. Price discovery is an important component of the deal and a bad bank is best suited for fixing price. A good bank should make additional provision in case the discovered cost is less than the book value and they want to retain it on its books.
4. ARCs have mostly not reconstructed assets as banks suffer loss on investment in security receipts after five years. Instances are there when defaulters have managed to reduce obligation to banks through purchase from ARCs in the name of sister/connected concern as provisions like Section 29A of the IBC are not included in the SARFAESI Act.

Selling stressed assets to a bad bank at a price determined by it will insulate bankers from the purview of 3Cs (CBI, CVC, CAG), and encourage them to offload these to a bad bank.

Countries like the UK, the US, Spain, Malaysia, France, Finland, Belgium, Germany, Austria and Sweden have successfully experimented with bad asset resolution through a bad bank. The earliest case was of the Mellon Bank in 1988—to hold bad assets of $1.4 billion. The UK Asset Resolution (UKAR), a bad bank, repaid 48.7 billion pound taxpayers’ loan that it had taken, and is close to selling the last of its asset portfolio before winding down. International experience should come handy for us to model our bad bank on.

Parliament may pass a legislation to set up a bad bank and empower it with the heft for recovering from borrowers, with minimal legal hassles with respect to acquisition/disposal of bank assets.

The author is former ED, UBI, and director (Rare ARC, Incred Finance and Baroda Trustee India Pvt Ltd)

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