New Structure of Bad Bank

News: Recently, the Union Cabinet approved the Rs 30,600 crore guarantee to back Security Receipts issued by National Asset Reconstruction Company Limited (NARCL) for acquiring stressed loan assets. The NARCL is a part of a new Bad bank structure that was announced in the Budget 2021.

Background:

  • The “National Asset Reconstruction Company Limited” (NARCL) has already been incorporated under the Companies Act.
  • It will acquire stressed assets worth about Rs 2 lakh crore from various commercial banks in different phases.
  • Another entity — India Debt Resolution Company Ltd (IDRCL), which has also been set up — will then try to sell the stressed assets in the market. The NARCL-IDRCL structure is the new bad bank. To make it work, the government has okayed the use of Rs 30,600 crore to be used as a guarantee.
  • It will be a five-year guarantee for the National Asset Reconstruction Company Limited (NARCL)-issued security receipts to banks. Under the mechanism, the NARCL will acquire assets by making an offer to the lead bank. Private sector asset reconstruction firms(ARCs) may also be allowed to outbid the NARCL.
  • Separately, public and private lenders would combine forces to set up an India Debt Resolution Company (IDRC) that would manage these assets and try to raise their value for final resolution.

Bad Bank

  • The bad bank is an Asset Reconstruction Company (ARC) or an Asset Management Company (AMC) that takes over the bad loans of commercial banks, manages them and finally recovers the money over a period of time.
  • The bad bank is not involved in lending and taking deposits, but helps commercial banks clean up their balance sheets and resolve bad loans. The takeover of bad loans is normally below the book value of the loan and the bad bank tries to recover as much as possible subsequently.
  • Commercial banks are saddled with high NPA levels, setting up of the Bad bank will help. That’s because such a bank will get rid of all its toxic assets, which were reducing its profits, in one quick move. When the recovery money is paid back, it will further improve the bank’s position. Meanwhile, it can start lending again.
  • Whether it is recapitalising PSBs laden with bad loans or giving guarantees for security receipts, the money is coming from the taxpayers’ pocket. While recapitalisation and such guarantees are often designated as “reforms”, they are band aids at best. The only sustainable solution is to improve the lending operation in PSBs.
  • The plan of bailing out commercial banks will collapse if the bad bank is unable to sell such impaired assets in the market. The burden indeed will fall upon the taxpayer.