The government is preparing to bring stressed assets worth Rs 2.25 lakh crore under the proposed ‘Bad Bank’. The entity which will be entirely funded and managed by commercial banks, said two top bureaucrats in an exclusive interaction on February 2.
As per the plan, bad loans above Rs 500 crore will be brought under the entity from 68-70 accounts, they said. The entity will be floated soon.
But, the government - which has initiated consultations with the Reserve Bank of India (RBI) on the proposed Bad Bank - will not have any direct participation in the proposed entity either in terms of funding or management control, said Debasish Panda (Secretary - Department of Financial services) and Tarun Bajaj (Secretary - Department of Economic Affairs) in the interview.
The funding will be done by banks from both the private sector and the public sector, they said. It is not clear what is initial capital estimated for setting up the Bad Bank.
Finance minister Nirmala Sitharaman, on February 1, announced an entity in the form of an asset reconstruction company/asset management company— commonly called a ‘Bad Bank’—to help the banking system get rid of the existing stock of problematic loans.
A Bad Bank is defined as an entity that absorbs the existing stock of Non-Performing Assets (NPAs) in the banking system and attempts resolution through a professional approach.
Bad Bank to use 15:85 model
Explaining the details about Bad Bank, Panda said the Bad Bank would function in a 15:85 mechanism. It means that banks will get 15 percent upfront payment as cash and 85 percent value as receipts.
“The government is not going to put any money, nor is it going to have any shareholding of Bad Bank,” Panda said.
The comments from the top bureaucrats on government’s passive participation in the Bad Bank is significant as the entire funding burden of Bad Bank will fall on the banking system. In May 2020, the Indian Banks' Association (IBA) had proposed the idea requesting the government to put in an initial capital of Rs10,000 crore. But, with the government bureaucrats clarifying that the Centre will not fork out money for Bad Bank, banks will have to shoulder the burden and operate the entity.
This will have capital implications on PSBs that own 60 percent of the assets in the banking system. Government has over 70 percent ownership in ten PSBs and over 90 percent in three.
‘Bad Bank’ to be floated soon
Panda said the Bad Bank will be floated soon in the ARC-AMC model and since banks have already made significant provisions, the capital burden on banks will not be huge.
“These are those assets for which banks have already made provisioning. So there will not be any impact on the bank's balance sheet,” Bajaj said. “By selling these assets, banks will get enough capital, which have been blocked and it will fully fill the capital requirement of the banks too.”
To be sure, the idea of a Bad Bank itself is not new. In 2018, the government announced a plan for PSBs called 'Project Sashakt', which had a five-point plan for bad loan resolution in public sector banks.
The government then spoke of a model, with the guiding principles of an Asset Management Company (AMC) resolution approach, under which an independent AMC would be set up to focus on asset turnaround, job creation and protection. The functions of this new company will be aligned with the Insolvency and Bankruptcy Code (IBC) process and IBC laws, the government said.
The government did not call it a Bad Bank then and made it clear that it won't get involved in the bad asset resolution process and the process will be led by banks. On January 27, Moneycontrol reported that a Bad Bank is likely to be announced in Budget 2021.
Nearly 8 percent of the total loans have gone bad (overdue more than 90 days) at this stage. In a recent interview with Moneycontrol, former SBI Chairman Rajnish Kumar said that time was ideal for creation of a Bad Bank.
“Today, the net book value of NPAs is very low—hardly 15 percent in many cases. The point is if there are people specialising in resolution and if all NPAs are brought to one place, bank management can focus on the rest of the business,” Kumar said.
“PSBs own 60 percent of the banking system. We can’t transfer (bad loans) to any other entity other than a government-owned company. This is the logic (of saying the government has to fund the project),” said Kumar.
Bad loan woes mount post COVID-19
The existing stock of bad loans is a big worry for banks. At the end of September 2020 year, the total gross NPAs of the banking system was 7.5 percent of the overall industry loan book.
This is expected to shoot up to 13.5 percent by March-September, according to the Reserve Bank of India’s (RBI) projection. That is a base case scenario. In the worst-case scenario, the bad loans are likely to rise up to 15 percent of the total loans.
This will be a big shock to banks as they will require significantly higher capital to cover the impact of bad loans. Moving the existing stock to a separate entity at the earliest could be an escape route.
COVID-19 has given an extra jolt on the bank balance sheets. The pandemic has impacted the overall economic activity significantly, inflicting pain on the balance sheets of banks. The six-month loan moratorium gave temporary relief to companies.
But, after the moratorium period, some of these accounts have been restructured by banks. Going by the numbers indicated by banks so far, the weaker banks have been impacted more.
To give an example, Yes Bank, which has one-third of its loans under the stressed category, has restructured around 5 percent of the loan book. Analysts expect overall restructuring in the industry (on account of COVID-19) to be around 3 percent of the loan book. A lot will depend on economic recovery going ahead.
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