Since our country’s financial system is predominantly bank-based, non-performing Assets (NPA) of Banks have significant impact on the country’s GDP. NPAs also generate a vicious cycle of effects on the sustainability and growth of the banking system, and if not managed properly could lead to bank’s failure.
Mounting NPA is a serious concern for all Banks and Financial Institution. Various Mechanisms for recovery from NPA such as Lok Adalats and DRTs have been in function for almost three decades but their recovery rates are not encouraging. Further, the covid-19 pandemic has an adverse impact on economic activity which has resulted in falling recovery rates drastically. Now the prominent question before Banks and their regulator is that, how to get rid of Bad Loans? It is not so, that government has not taken any efforts to reduce the Bank’s worry. The government has restructured the policies, made amendments, and brought new laws such as Sick Industrial Companies Act, (SICA), The Securitisation and Reconstruction of Financial Assets and Enforcement of Securities Interest Act, (SARFESI). Debt Recovery Tribunals were established specifically for Bad Loan’s recovery but not yield the desired result. Assets Reconstruction Companies (ARCs) were also set up as part of SARFAESI Act, 2002 as an instrumental alternative for NPA resolution in India and as on January 2021, 28 ARCs are in operation. The problem with ARCs is that they lack the bandwidth to reconstruct any company under stress which is sold as going concern. ARCs purchase bad loans from various banks and proceed to recover loans on their own. In return, for selling these assets, banks get an upfront cash payment of at least 15%, and the rest in the form of security receipts, redeemable as and when the loans are recovered.
In the year 2016, the much awaited and debated Act, the Insolvency and Bankruptcy Code, (IBC) was formulated which empowered the creditors to drag the wilful defaulters to National Company Law Tribunal, NCLT. Initially it was projected as the most successful tool for the recovery of bed loans through revival and resolution but in reality, the situation still remains the same and bankers are carrying the bad debt quarter by quarter.
In view of the inadequacies in the existing system and due to the flagging position of NPAs and associated capital adequacy and lending capacity issues of banks, there was a dire need of an Institution specifically designed for Recovery of Bad Loans, and in line with this, government has set up yet another resolution mechanism, named ‘Bad Bank’ under the ARC (Assets Reconstruction Company) and AMC (Assets Management Company) model to tackle the mountain of defaulted debt that threatens to cripple its financial system.
The concept of Bad Bank is that the Bad Assets or NPAs of PSU Banks will be transferred to the Bad Bank and the bad bank, being a dedicated bank to deal with the bad assets, will work only to recover from the bad accounts. The concept looks very simple and straight forwarded, but one concern arises here is that, when special Acts like SICA, SARFESI and IBC has failed and the dedicated Recovery Agencies i.e. ARCs could not yielded desired outcome, how the new Bad Bank, which is also a kind of ARC, would succeed? Whether transfer of bad loans from one government owned entity to another government owned entity is sufficient to convert the bad assets into good assets? This concern is very genuine, because India’s earlier experience with Bad Banks have left a feeling of incredulity. In the year 2004, IDBI Bank had created a wholly-owned special purpose vehicle in the form of Bad Bank and bad loans worth over Rs 9,000 crores were transferred to it for recovery. But unfortunately, neither IDBI could realise substantial amount from Bad Loans nor its lending record improved.
Pursuant to the establishment of a bad bank, the NPAs would be transferred from the banks to the bad banks. This would definitely clean up the balance sheets of the bank but it would not solve the problem of mounting NPAs. The banks will tend to continue their incautious lending practices and become complacent as they would have the bad bank as a tool to clean their balance sheets.
Bad banks have been institutionalised and considered a success in several countries and no doubt it may accomplishing its mission in India, provided it is implemented effectively. Secondly, wherever a Bad Bank has succeeded, it is because new money has come in. The new money will only come when there is a hassle-free acquisition. While one acquires at a price, the other has to arrange for a buyer at a price which is commercially viable. If there is no buyer at the price, each will look at the other distraught. In India, there is no separate market available where bad assets can be sold. There is no securitisation market in the Country. The bad bank will also deal with the same ARCs, Vulture Funds, and investors who are dealing with the banks now.
India has set up Bad Bank in form of National Assets Reconstruction Company limited (NARCL) but as of now the government does not have any road map regarding the functioning of the bad bank. Mr. Siby Antony, a former chairman of Edelweiss ARC has rightly said “It is an experiment whose outcome will depend on its execution”. One thing we need to accept and understand here is that, in India, policies and institutions have failed due to lack of compliance, lack of enforceability and lack of proper management. India’s Bad Bank should develop a unique and sustainable business model with proper management and strict regulatory compliance, otherwise the establishment would be nothing but changing hand for NPA from one institution to another.
Bad bank is no solution, if it simply transfers bad loans from one government-owned entity to another without changing the incentives to make bad loans at the seller or improving the ability to collect at the buyer. Famous journalist and novelist Mr. Charles Dickens once said, “A person who can’t pay, gets another person who can’t pay, to guarantee that he can pay.” Similarly, establishing Bad Bank with lacklustre implementation, would be same as banks who can’t recover their dues, are setting up another bank to recover for them.