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Explained: Bad bank is ready, how will it resolve stressed assets?

The bad bank — National Asset Reconstruction Company Limited — is ready to commence operations with 15 cases worth Rs 50,335 crore to be transferred by March 31.

Written by Sunny Verma , Edited by Explained Desk | New Delhi |
Updated: January 31, 2022 8:38:04 am
Finance Minister Nirmala Sitharaman tabled the Economic Survey in the Lok Sabha on Monday. (File Photo)

A key proposal announced in this year’s (2021) Budget, a bad bank to deal with stressed assets in the loss-laden banking system, has received all regulatory approvals.

What is the structure of the bad bank?

NARCL will acquire and aggregate the identified NPA accounts from banks, while IDRCL, under an exclusive arrangement, will handle the debt resolution process, State Bank of India Chairman Dinesh Khara said on Friday in a press conference.

Padmakumar Nair, a Chief General Manager from SBI’s Stressed Assets vertical, will manage NARCL, while Manish Makharia, Head of Alternate Investment Fund, SBI Funds Management Pvt Ltd, will head IDRCL.

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Subrata Biswas, the nominee director on the Board of NARCL, will be the interim Chairman, and Diwakar Gupta will continue as the Chairman of IDRCL.

Khara said that although “certain concerns” were raised, eventually both NARCL and IDRCL have received the requisite approval. The concerns mainly arose on the dual ownership structure and operational mechanism, with the setting up of two separate entities NARCL and IDRCL.

“This is a structure which has been envisaged for the first time, and whatever time has been taken, it is essentially to iron out some of the issues which could have possibly come up in future. So, they have all been ironed out and they have been appropriately addressed. And so, that the functioning of both entities should be smooth, and they should be in a position to achieve the objective for which they’re brought into existence,” he said.

Majority-owned by state-owned banks, the NARCL will be assisted by the India Debt Resolution Company Ltd (IDRCL), in turn majority-owned by private banks, in resolution process in the form of a Principal-Agent basis.

How will the bad bank work? What does the Principal-Agent mechanism entail?

NARCL and IDRCL will have an exclusive arrangement that will be as per the scope defined in the ‘Debt Management Agreement’ to be executed between these two entities. This arrangement will be on a ‘Principal-Agent’ basis and final approvals and ownership for the resolution shall lie with NARCL as the Principal, Khara said.

While he argued that this is as per the structure “originally envisaged”, the Indian Banks Association (IBA) is learnt to have wanted a dual structure with the asset management company or AMC as a privately held entity, to be out of the purview of the regulatory entities.

That would have given it requisite flexibility to deal with the resolution process, as normally a single entity is accountable as owner and for recovery of the assets in the asset reconstruction business. But now, with the ‘Principal and Agent mechanism’ that has been put in place to address regulatory concerns, the final approvals will still be done by NARCL as the Principal.

So, even though IDRCL is majority-owned by private banks, the final authority will rest with NARCL, which is majority-owned by public sector banks. This has been done possibly to address regulatory concerns around the bad bank structure.

Finance Minister Nirmala Sitharaman had in her February 1, 2021, Budget speech proposed a new structure for the resolution of stressed assets.

“The high level of provisioning by public sector banks of their stressed assets calls for measures to clean up the bank books. An Asset Reconstruction Company and Asset Management Company would be set up to consolidate and take over the existing stressed debt and then manage and dispose of the assets to Alternate Investment Funds and other potential investors for eventual value realisation,” she had said.

What kind of resolutions are expected?

The asset resolution will be done in a phased manner. A total of 38 accounts aggregating Rs 82,845 crore have been identified for transfer to NARCL.

In the first phase, at least 15 accounts worth Rs 50,335 crore will be transferred to the proposed bad bank by March 31. Initially, an estimated Rs 2 lakh crore worth of bad assets was planned to be transferred; however, some of these accounts have already been resolved and further resolutions will happen as and when referred to the bad bank.

With a combination of post-Covid moratorium and recoveries, there was an actual decline in NPAs from Rs 8.40 lakh crore in 2020 to Rs 7.80 lakh crore in 2021.

In a press statement, SBI said IDRCL is expected to bring in superior resolution techniques, preserve the value, showcase brownfield assets, and attract domestic as well as foreign investors, Alternate Investment Funds, etc. This will free up capital for further bank lending, it said.

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What will the government guarantee?

The NARCL will purchase these bad loans through a 15:85 structure, where it will pay 15 per cent of the sale consideration in cash and issue security receipts (SRs) for the remaining 85 per cent. The SRs will be guaranteed by the government. The government guarantee will essentially cover the gap between the face value of the security receipts and realised value of the assets when eventually sold to the prospective buyers.

The government approved a 5-year guarantee of up to Rs 30,600 crore for security receipts to be issued by NARCL as non-cash consideration on the transfer of NPAs. This will address banks/RBI concerns about incremental provisioning.

Government guarantee, valid for five years, helps in improving the value of security receipts, their liquidity and tradability. A form of contingent liability, the guarantee does not involve any immediate cash outgo for the central government.

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