After much delay, the so-called Bad Bank is finally ready to take off. On 28 January, at a video press conference called at a short notice, State Bank of India (SBI) chairman Dinesh Kumar Khara announced that the project had received all necessary approvals to take off. Around 15 cases worth Rs 50,000 crore will be transferred to the proposed bad bank in this financial year, he said. An estimated Rs 2 lakh crore worth of bad assets are planned to be transferred to the Bad Bank.
A total of 38 accounts with Rs 83,000 crore outstanding in total have been identified for transfer so far but some have been resolved already, Khara added. The dual structure of Bad Bank will be a public-private collaboration with public sector banks having a majority stake in the National Asset Reconstruction Company Ltd (NARCL) while private banks will have a significant stake in India Debt Resolution Company Ltd, he said.
So far so good. But what’s next?
For sure, the Bad Bank’s journey won’t be a smooth one—even with all that government backing and banking sector. There will be two key challenges—valuation and asset resolution.
Remember, the bad assets waiting to be absorbed by the Bad Bank are really bad assets, which means banks have already tried to resolve these cases for several years but clearly haven’t had much luck. Banks transferring these assets will always want the highest possible valuation but the asset reconstruction companies getting these assets would want a cheaper deal.
Thus, to begin with, most of these bad assets are already fully provided for, written down accounts on the books of banks. They no longer nurture hopes of any meaningful recovery from these assets. Coming to the Bad Bank deal, the most critical part will be how banks arrive at a valuation for the transfer of these assets to NARCL.
Even if some mechanism for price discovery is worked out, the value of the assets is unlikely to exceed 10 percent to 20 percent of the assets at the time of transfer. Banks will want maximum value for the assets being transferred.
The second challenge is the timely resolution.
According to details shared by the finance minister at a press conference last year, banks will receive 15 percent of the value of assets being transferred upfront in cash; 85 percent will be given as security receipts (SRs). If the debt resolution doesn’t happen within a five-year period, the government will have to pay banks against the SRs if the guarantee is invoked. There are no takers for such assets. Bad Bank managers will have their task cut out.
The limited success of the earlier asset resolution mechanisms including debt recovery tribunals, existing asset reconstruction companies (ARCs) and corporate debt restructuring mechanism shows how difficult it is to get such assets back to performing ones and find value in such assets and get takers. Nevertheless, the Bad Bank is a step in the right direction. Hopefully, this will help the Indian banking sector--saddled with bad loans-- to clean up their books and be ready for a fresh start.But proper execution and asset resolution will be key to make sure the project doesn’t meet the fate of some of the earlier much-hyped initiatives.(Banking Central is a weekly column that keeps a close watch and connects the dots about the sector's most important events for readers.)