Economic Survey explains the need for bad bank
Many experts have wondered what was the need for the government-backed asset reconstruction company – National Asset Reconstruction Company Ltd (NARCL), or bad bank, when there are 28 private ARCs already operating in the country, and the need for a new debt resolution body when we already have a whole ecosystem under Insolvency and Bankruptcy Code.
The Economic Survey 2022 has an explanation for the same. It says that various available resolution mechanisms, including Insolvency and Bankruptcy Code (IBC), SARFAESI Act, Debt Recovery Tribunals, etc. have proved to be useful to certain extent, however a large stock of legacy NPAs are yet to be resolved.
In further says that while there are 28 ARCs existing in India, due to limited capitalisation and low recoveries from existing portfolio, they are better placed for acquiring only smaller value loans.
Therefore, it argues that in order to resolve the legacy NPAs and clean up the banking system, the Union budget 2021-22 announced the formation of a bad bank.
“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 (ARC) Limited and Asset Management Company (AMC) 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 realization,” the Budget last year had reasoned.
Structure and ownership of NARCL, IDRCL
In line with this vision, two entities — National Asset Reconstruction Company Limited (NARCL), and India Debt Resolution Company Limited (IDRCL) have been formed.
NARCL was incorporated on 7th July 2021 and has received a certificate of registration from the RBI to commence the business of an Asset Reconstruction Company on 4th October 2021. NARCL will majorly be owned by Public Sector Banks. Canara Bank is the Sponsor with shareholding of up to 12 per cent. NARCL would be capitalized through a combination of equity and debt from various Banks and will have a finite life of 5 years. It may acquire stressed assets of about Rs 2 lakh crore appox in multiple phases within the extant regulations of RBI under 15:85 structure, implying that the consideration for acquisition will be 15 per cent in Cash and 85 per cent in Security Receipts.
IDRCL was incorporated on 3rd September 2021 and will have minimum of 51 per cent ownership of Private sector Banks and balance will be held by Public Sector Banks. NARCL and IDRCL’s relationship will be defined through a debt management agreement where in NARCL will aggregate and acquire the stressed assets and IDRCL, in turn, will provide stressed assets management and resolution services to NARCL on an exclusive basis.
How the two complement each other
The term of IDRCL shall be co-terminus with that of NARCL, says the Economic Survey. NARCL, or the bad bank, will acquire assets by making an offer to the lead bank and the lead bank with an offer in hand (of NARCL) will run a ‘Swiss Challenge’ process wherein other interested ARCs / Bidders will be invited to better the anchor offer made by NARCL.
The survey further explains: “Once NARCL is declared as a preferred bidder, NARCL shall initiate asset acquisition process and acquire the assets in the underlying Trusts. After acquiring the assets, IDRCL shall prepare and suggest the proposed restructuring / resolution plan, strategies, etc. for each Underlying Trust Assets. Post the approval of resolution from NARCL, IDRCL will also assist in implementation of resolution.”
The assets acquired shall be resolved using existing resolution tools within the RBI framework for ARCs. Resolution mechanisms of this nature typically require a backstop from Government as it imparts credibility and provides for contingency buffers.
Globally, explains the Economic Survey, bad banks have been set up with Government participation in the form of equity along with other regulatory dispensations, for instance, Danaharta Nasional Berhad (Danaharta) in Malaysia or Asset Resolution Ltd (UKAR) in UK.
Therefore, taking the precedence from international practices, in India, the government has provided a guarantee of up to Rs 30,600 crore, which will back Security Receipts (SRs) issued by NARCL. The government guarantee will be valid for 5 years.
Guarantee available for these SRs may be invoked on completion of resolution or liquidation as the case may be to cover the shortfall between actual realization and face value of the asset. The guarantee amount will be issued based on actual assets acquired by NARCL. This arrangement will not only safeguard the face value of Security Receipts but it will also take away the need for 100 per cent upfront capitalization of NARCL. The government will charge a guarantee fee on the amount which it guarantees, which will increase annually to incentivize the early and timely resolution.
