July 1, 2022
  • July 1, 2022

How bad banks offer a fresh start to the Indian economy

By on September 26, 2021 0

The history of bad loans by banks and corporate taxpayer dollars seems to have reached a turning point. On September 16, Finance Minister Nirmala Sitharaman announced the creation of a “bad bank”, which the Center had previously proposed in its 2021-22 Union budget. A bad bank is a financial institution that takes charge of bad loans (NPAs, or non-performing assets) on the books of other banks, which cleans up their balance sheets and allows them to resume normal activities. As Union Finance Minister Nirmala Sitharaman described it, bad banks “will take over existing debt, manage it and cede it to buyers to realize the value of stressed assets”.

Finance ministry officials said the banks had identified around 90,000 crore of bad debt to be transferred to the National Asset Reconstruction Company Limited (NARCL). In the first phase, fully provisioned assets of approximately Rs 90,000 crore are expected to be transferred to NARCL.

“A substantial amount of NPA [remain] on bank balance sheets, mainly because the bad debt stock as revealed by the asset quality review is not only large but fragmented among various lenders. The high provisioning by the banks against the old NPAs presented a unique opportunity for a faster resolution, ”said the Ministry of Finance on the rationale for the creation of the bad bank.

The beginning

The idea of ​​creating a bad bank was raised to clean up the balance sheets of banks that were bogged down in NPAs. RBI data shows that the gross NPAs of SCBs (programmed commercial banks) increased from Rs 3.23 lakh crore at the end of March 2015 to Rs 10.36 lakh crore at the end of March 2018. This increase was mainly the result of transparent recognition stressed people. active as postcode. The government’s strategy of recognition, resolution, recapitalization and reforms saw NPAs drop to Rs 8.34 lakh crore (according to provisional data) at the end of March 2021.

DK Srivastava, chief policy adviser at EY India, says that while the initiative appears to be “very well thought out” there will be a lot of technical evaluations involved and lenders will have to agree to a certain “haircut”. (A haircut refers to the less than market value placed on an asset set aside for collateral). A significant number of assets that served as collateral for the loan are real estate assets whose valuations vary according to their location, size, etc. These assets will need to be valued and auctioned, etc. There will also need to be some sort of standardized process for valuing assets of different kinds.

The success of the bad bank will also depend on the extent of the loss that the banks are willing to accept when surrendering their NPAs. But even with a haircut, economists say it’s the best option to hit the banks’ reset button and let them start lending again. With the real estate market recovering, “now is a good time for asset values,” says Srivastava.

NARCL is expected to buy back Rs 2 lakh crore of bad assets over time, around 45% of what all ARCs (asset rebuilding companies) collectively acquired until March 2021 (around Rs 4.5 lakh crore) . This is significant, not only in the context of banking industry NPAs, but also for the CRA industry. The move also highlights the critical role that NARCL and India Debt Resolution Company Ltd should play in managing and resolving bad corporate assets in the national banking system. “Their success will depend on time-bound resolutions and the extent of recoveries,” said Krishnan Sitaraman, Senior Director and Deputy Director of Ratings, CRISIL Ratings. With the establishment of a bad bank, a new start to reform the Indian banking system has been made. To be successful, this must go hand in hand with much needed reforms in loan due diligence, better governance, early detection of stress, etc.