Bad bank: Should India have one?

We have 29 ARCs buying bad assets, but the model has

not yielded desired results. Meanwhile, developed
nations have tasted success with bad banks

There is added urgency because the government has put on hold, rightly so, fresh reference to the
NCLT under the IBC for one year.

By Deepak Narang

The debate over a ‘bad bank’, keenly discussed in the official circles and the
media in FY17, has been in the focus once again after the IBA sent a proposal for
establishing a bad bank to the government and RBI. Earlier, RBI toyed with the
idea of a private asset management company and a national asset management
company for private and public sector banks, respectively.

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At present, banks have NPAs of Rs 9.7 lakh crore (as of December 2019) with
estimates of fresh slippages of Rs 5.5 lakh crore primarily because of the Covid-
19 stress. We have to look for quick solutions. There is added urgency because
the government has put on hold, rightly so, fresh reference to the NCLT under
the IBC for one year.

A bad bank is established to buy toxic assets from a good bank at a price that is
determined by a bad bank. It is controlled by the government, and apart from
the government, other private players invest in its equity. It may raise loan from
other banks. These transactions happen at arm’s length and a bad bank is
managed by professionals with domain knowledge.

In India, a bad bank has not been set up; rather, private asset reconstruction
companies (ARCs) have been buying NPAs from various banks—and 29 ARCs
are in the business of buying bad assets but the model has not yielded desired
results. ARCs act merely as recovery agents because they lack the bandwidth
to reconstruct any company under stress which is sold as going concern. The
efficacy of the ARC model is under question. The CVC, some time ago,
submitted a report to the government after examining cases above Rs 50 crore
that were sold to ARCs between 2013-14 and 2017-18 by PSBs. The report
mentions that, in at least 48 cases, assets were sold to ARCs below the
realisable value of security. Besides the accounts which were sold as going
concern, the value of stocks and equipment were not factored in while fixing the
reserve price.

This has acted as a dampener and sale to ARCs is few and far between now.
Besides, ARCs have recovered roughly 9.5% of the security receipts that they
held at the end of FY18. We need to keep in mind that all PSBs have board-
approved policy for sale to ARCs and cases of Rs 50 crore should have been
placed before the board for sanction/approval.

If the economy has to come back on track, then lending has to resume in a big
way. As a rule of thumb, credit growth is roughly 2-2.5 times GDP growth.

Setting up a bad bank, undoubtedly, is a way forward. The case of Jhabua

power plant can be examined to understand the desirability of a bad bank.
Jhabua Power for resolution of insolvency was under the IBC on account of
shortage of working capital. Two bids were received—one from the NTPC,
which made the bid for the first time for Rs 1,900 crore at the rate of Rs 3.2 per
MW, and another from Adani Power, for Rs 750 crore at Rs 1.25 per MW. Had
the NTPC not entered the fray, the plant, in all probability, could have been
purchased by Adani Power may be after some increase of price post bargaining.

In this case, not only the price was higher, but profit, if any, will go to
government coffers. The cost to the exchequer will, therefore, be either nil or
minimal. Such deals may, subsequently, invite wrath of the CVC/CBI. A bad bank
can do this work as it will have the bandwidth to deal with such situations and
can rope in experts to manage units/plant till it finds a buyer. Besides, it may
share future profits with the bank that sold this asset.

Arguments against establishing bad banks are: (1) When there are no takers
for bad assets, so why have a bad bank; (2) Why waste government resources
when the Covid-19 crisis has put tremendous strain on resources; (3) The price
at which toxic assets will be transferred will not be market-determined and price
discovery will not happen; (4) ARCs are already there for the purpose.

Let us provide a different perspective to these issues.

1. If there are no takers for the assets, then it makes sense to let domain experts
deal with toxic assets till these can be sold.
2. As in the case of Jhabua Power and in most cases of Rs 500 crore and above,
the government may suffer minimum loss.
3. Price discovery is an important component of the deal and a bad bank is best
suited for fixing price. A good bank should make additional provision in case the
discovered cost is less than the book value and they want to retain it on its
books.
4. ARCs have mostly not reconstructed assets as banks suffer loss on
investment in security receipts after five years. Instances are there when
defaulters have managed to reduce obligation to banks through purchase from
ARCs in the name of sister/connected concern as provisions like Section 29A of
the IBC are not included in the SARFAESI Act.

Selling stressed assets to a bad bank at a price determined by it will insulate

bankers from the purview of 3Cs (CBI, CVC, CAG), and encourage them to
offload these to a bad bank.

Countries like the UK, the US, Spain, Malaysia, France, Finland, Belgium,
Germany, Austria and Sweden have successfully experimented with bad asset
resolution through a bad bank. The earliest case was of the Mellon Bank in 1988
—to hold bad assets of $1.4 billion. The UK Asset Resolution (UKAR), a bad
bank, repaid 48.7 billion pound taxpayers’ loan that it had taken, and is close to
selling the last of its asset portfolio before winding down. International
experience should come handy for us to model our bad bank on.

Parliament may pass a legislation to set up a bad bank and empower it with the
heft for recovering from borrowers, with minimal legal hassles with respect to
acquisition/disposal of bank assets.

The author is former ED, UBI, and director (Rare ARC, Incred Finance and
Baroda Trustee India Pvt Ltd)

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