The central government announced the formation of Bad Bank last month. The announcement of creating a bad bank was made by Finance Minister Nirmala Sitharaman in the budget this year. The government has set up the National Asset Reconstruction Company Limited (NARCL) under the Companies Act. It has been decided that NARCL will buy bad loans (NPA) of Rs 2 lakh crore on the account of commercial banks at a mutually negotiated price.
A complex mechanism has been developed for the subsequent process and India Debt Resolution Company Limited (IDRCL) will assist NARCL in resolving the bad debt.
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But this much awaited bad bank of India has also raised a lot of questions. The biggest question is whether bad banks are the solution to the chronic NPA problem of Indian public banks?
First of all, it needs to be understood that bad banks are going to buy only one fourth of the total NPAs of PSU banks. According to the information given by the government in Parliament, as of September 2020, the total NPA of PSU banks is a little more than Rs 8 lakh crore. This amount was Rs 10.36 lakh crore in March 2018. This does not mean that banks have recovered bad loans of 2 lakh crores in two years.
This reduction in NPAs is mainly a result of banks writing off bad loans from their books. The write-offs of banks have increased steadily since the introduction of the Asset Quality Review by the Reserve Bank of India in 2015. While banks wrote off Rs 70,000 crore in 2015-16, this amount rose to Rs 2.4 lakh crore in 2019-20.
However, in the meantime the NPAs of banks continued to increase. In the year 2018-19, Rs 1.3 lakh crore of public sector banks went into the NPA category, while in 2019-20, an amount of Rs 2 lakh crore turned into NPA. It is clear that the one-time transfer of 2 lakh crores in the bad bank is only a beginning, not a solution.
It is also important to understand here that the formation of a bad bank and transfer of NPAs will be done only once. This is also necessary because if it is made a system that banks keep their loan amount as NPA and the same is transferred to NARCL, then it will be catastrophic for the entire financial system.
Therefore, the bad bank should not make the mistake of treating the NPA problem as a solution. Then what is the meaning of formation of bad bank?
The one and only objective of Bad Bank or NARCL is to free the balance-sheet of the banks because as per the regulation of the Reserve Bank, the banks have to provision an amount equal to the amount of NPA. That is, if the public sector banks have 8 lakh crore NPAs, then they must have made a provision of 8 lakh crore rupees.
Obviously, due to this, 8 lakh crore rupees have become unproductive out of the total amount with the banks and they can neither be given loans to any corporate nor can be used for any other work. By transferring Rs 2 lakh crore to the bad bank, the same amount will be immediately available with the banks, which they will be able to give in the form of loan to the companies. It is very necessary to accelerate the growth rate of the country.
In this sense, isn’t a bad bank akin to avoiding or turning a blind eye to the problem?
To a large extent this is correct. If the government does not take concrete measures to prevent the formation of new NPAs, then bad banks may not be very effective. The irony is that the government has no panacea to prevent new NPAs from forming.
In view of the kind of economic situation created in the country after COVID-19, the Reserve Bank announced a moratorium to give relief to the borrowers in the return of loans. This is sure to increase NPAs. Apart from this, until the cycle of the economy becomes bullish, the debt of companies will continue to turn into NPA.
How will Bad Bank work?
The bad bank will buy bad loans from public sector banks at cheaper rates and restructure them and sell them to other corporates or investors. At whatever price NARCL buys the NPA, that seller will give an advance of 15 percent in the form of cash to the bank and issue a security receipt for the remaining amount, which can be bought and sold further.
These receipts will be guaranteed by the government, although the amount of guarantee will not exceed Rs 30,600 crore in any case. The buyer of the receipt can claim this guarantee only after the bad asset is disposed of.
It is to be noted here that even before the bad banks, there have been efforts to settle bad loans by selling them at cheaper rates and for this there are dozens of Asset Reconstruction Companies (ARC).
But these companies have not been able to get any significant success in resolving bad loans so far. A major reason behind this is that there is no guarantee behind the security receipt. But behind the receipt of the bad bank is the guarantee of the government itself.
In such a situation, it can be expected that this experiment of bad bank will be successful and more money will be available with the banks to give corporate loans in future.
(The author is an expert in agriculture and economic affairs)