The idea of bad bank is back. The banking industry lobby, the Indian Banks Association (IBA), has reportedly taken up this idea with the government. The IBA is considering an ARC-AMC model to create a bad bank and segregate all bad assets from PSBs and private banks into a separate entity. The idea is that this exercise will clean up bank balance sheets and they can focus on fresh lending.
A bad bank is essentially an entity which bundles together all the bad assets in the banking industry, buys it at a discounted price from banks and tries to find buyers by putting a turnaround plan in place. The purpose of creation of a bad bank is not very different from a typical ARC (Asset Reconstruction Company).
According to senior bankers and industry officials, there is no clarity on the final contours of the proposed bad bank and, the capital structure. The plan appears to be that the government will contribute initial capital to make the structure work and later banks will pool in money along with outside investors, which may include private funds with specialisation in asset resolution.
The idea is not new. In 2018, the government had 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 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 Insolvency and Bankruptcy Code (IBC) process and IBC laws, the government had said.
The government didn't 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. With this, an alternative investment fund (AIF)-based resolution approach for loans above Rs 500 crore was also discussed under which an AIF would raise funds from institutional investors. Banks, too, will have an option to participate, if they wish to participate on the upside. The idea could not be executed for various reasons.
The talk about 'bad bank' bears a resemblance to 'Project Sashakt', albeit in a different avatar. The idea is good and more workable now since banks have already made 70-80 percent provisions on the NPAs after the mega clean-up exercise. They can remove the remaining by transferring the assets to a different entity.
But there are two parts to the problem. Taking the bad assets off the books of PSBs to a new entity and eventually selling to a willing buyer based on a turnaround plan. The first one is easy; the second is not.
The reason why banks want to create a government-owned asset reconstruction company and not to sell the bad loans to any of the existing 27 ARCs is the pricing. Typically, ARCs ask for a steep cut while purchasing stressed loans. Bankers bargain, ARCs bargain and both go home with no deal. Once the government/ banks-owned bad bank comes into existence, this issue won't crop up. Since the idea of creation is clear, the 'bad bank' won't bargain much while taking over the stressed assets as government has already given the funding.
But, the issue arises when it comes to the second part—while selling these loans to a potential buyer and resolving the underlying crisis in the system. If there are no deep-pocket buyers willing to put money on the table or if there is lack of private participation, the resolution plan may hit a roadblock. In the absence of a strong turnaround plan, the bad bank plan can backfire since this will be only transferring the risky assets in the banking system from one place to the other. This could lead to a crisis at a later stage since the underlying stress remains.
"There are benefits to the idea (of the creation of a bad bank). And this time, it seems more practical since banks have made provisions already. But, the pain is always on the resolution. Ultimately, the question is always who will put money and where are the buyers?” said a senior banker who was executive director of a state-run bank and is now associated with one of the private ARCs.
Banks' total gross NPA, as on December 2019, stood at Rs 7,97,505 crore. With one third of bank loans under moratorium and a sizable chunk of loans are SMA-2 or loans overdue between 61 days to 90 days, the actual chunk of loans could go up further. The resolution of stressed assets even in the IBC (Insolvency and bankruptcy code) route has not been very successful so far, except in the cases of a few large loans.
Finding buyers for bad assets in a COVID-19 hit economy will be even tough. The bottomline is unless there is a clear plan for the turnaround of the stressed assets - most of which are infrastructure and steel projects - the ‘bad bank' plan will be more like bundling small problems into a big one. One needs to wait and watch how the plan takes off this time.