By Dr K Srinivasa Rao
With the Reserve Bank of India granting licence to National Asset Reconstruction Company Ltd (NARCL), October 4 marks a historic development in the financial sector. NARCL is set up to declutter banks from part of the burden of non-performing assets (NPAs). Unlike the other existing private sector asset reconstruction companies (ARCs), it has more credibility with the government guaranteeing security receipts (SRs) to be issued in lieu of transfer of NPAs from banks to NARCL to the tune of Rs 30,600 crore in the next five years – a contingent liability for the government. It is akin to some of the global practices to use government-backed ARCs like the one formed in South Korea, Malaysia and Thailand after banks were hit by the global financial crisis of 2008.
Another unique move is to simultaneously set up India Debt Resolution Company Ltd (IDRCL), an operational entity meant to manage assets and collaborate with market professionals and turnaround specialists to unlock optimum value from the underlying assets. Public and private banks together will hold more than 51% in NARCL and up to 49% in IDRCL.
The capital of NARCL, initially put at Rs 6,000 crore, will be used to buy NPAs from banks by paying 15% upfront against the cost of acquisition of NPAs with SRs to be issued for the rest. Full provision is already made by banks against the proposed transfer of high-value NPAs of Rs 500 crore each and above amounting to Rs 90,000 crore. Such shift of NPAs will enable banks to trim down their assets and improve capital adequacy ratio creating additional room for fresh lending.
In a bold move to clean up bank’s balance sheets, a process that started with the Asset Quality Review of RBI in September 2015, the formation of NARCL will be able to realise its end state objective of ‘distressing the banking sector’. It came up as part of ‘Indradhanush’, the next generation 7-pronged bank reform package articulated after the first banking conclave – Gyan Sangam held in January 2015. The urgency to address the bad loan menace was exacerbated due to the onslaught of the pandemic.
Unlike the 28 ARCs operating now as non-banks to buy NPAs from banks and resolve them, the NARCL is differently designed to make it work quickly and efficiently to unlock the value of underlying impaired assets. The stakeholders have rightly diagnosed the reasons for the lull in the performance of ARCs and reinforced the new entity with a host of enablers and systemic controls.
These include: government guarantee of Rs 30,600 crore available for invocation to make good the difference between value realised from the NPAs and face value of SRs; formation of IDRCL to operationalise the process of debt resolution with a cross-section of experts working on it to realise better value; progressive increase in guarantee fee from 0.25% from second year onwards to 2% in third/fourth and fifth year on the outstanding unrealised SRs can hasten resolution; government support may end in five years by when most of the proposed total NPAs of Rs 2 lakh crore will get resolved.
Near Term Solution
At a time when faster slippage of retail and MSME loans are expected to increase the level of NPAs from Rs 8.35 lakh crore in March 2021 to Rs 10 lakh crore by March 2022, the NARCL can be essential as a near term measure. But it cannot be a panacea against the tendency of built-up of bad loans in the normal course of banking operations. Credit risk management is an integral function of banks that includes recovery of loans. It is necessary for banks and regulators to find out the precise reasons for the rising NPAs, and its management control on asset quality cannot be shifted to another entity.
Banks should be capable to lend and recover the loans as part of regular banking operations. The legal recovery tolls/framework, including Insolvency and Bankruptcy Code-2016, has to be revamped. The borrowing community should be made accountable for repayment in time so that seamless flow of credit to ensure sustained growth of the economy can be ensured. The five-year validity of government guarantee of SRs is a clear sign that banks have to reform their credit management systems in the next 2-3 years so that the accumulation of NPAs do not hinder their growth and sustainability.
The setting up of NARCL is a desperate move to revive the flow of credit at a time when the economy needs active banks. It clearly underlines that banks could not cope with challenges in managing asset quality in the normal course of business. It is time stakeholders introspected seriously about why a Bad Bank is needed when the whole legal and loan recovery ecosystem has been gradually strengthened. Despite the institutionalisation of several early alert systems to stem loan degradation, the missing links in asset quality management continue.
Either the quality of credit origination is not up to the mark or the subsequent monitoring of credit is not adequate to improve the quality of credit risk management. Banks have to introspect and fix the missing gaps using the Bad Bank as a temporary, one-time respite so that dependency on it could be reduced in the next five years. The long-term sustainable policy is not to rely on the Bad Bank but to improve its own efficiency in managing credit. Stakeholders should quickly use the Bad Bank as a respite to improve the resilience and robustness of the financial sector to sustain independently.
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