Firstly, the government announced the Automobile PLI policy with outlay of over Rs26,000cr. Secondly, the Telecom Relief Policy was also announced to give the much needed breathing space to telecom sector. On 16th September, the government came out with guidelines for the long awaited Bad Bank with assured government guarantees of up to Rs30,600cr.
There had been a lot of questions about the Bad Bank like how much of stressed assets will the Bad Bank take on and what would be the extent of the guarantee? There have also been questions about the logic of a Bad Bank, when there were 28 registered ARCs in India. Here is why the Bad Bank is a good development.
How exactly will the Bad Bank work?
It will be officially known as the National Asset Reconstruction Corporation Limited (NARCL), although informally, it will be referred to as the Bad Bank. Nirmala Sitharaman has pointed out that Indian banks had recovered loans worth Rs5 trillion in the last 6 years with 60% of the recoveries coming in the last 3 years. This underlined the urgent need to push through the Bad Bank idea.
Here is how the Bad Bank will work. The NARCL will take over stressed loans to the tune of Rs200,000cr from banks. Based on the assessment of the net asset value of these loans, the NARCL will pay 15% of the NAV in cash and the balance 85% in security receipts. In other words, if the actual NAV of the loan is 50% of the loan amount, then the cash amount will be 7.5% of the loan amount.
The bigger merit of this system is that these security receipts (SRs) will be guaranteed by the central government up to Rs30,600cr value. However, this guarantee will have a tenure of 5 years after which it will expire. Let us look at this guarantee in greater detail.
Why is the guarantee important for Bad Bank?
What does the government guarantee of up to Rs30,600cr mean? It is meant to provide greater credibility so that the banks are willing to invest in the capital of the NARCL. The NARCL will be registered as an ARC with the RBI and will be 51% owned by PSU banks.
Remember, the government guarantee of Rs30,600cr will be to meet the shortfalls in SR value. Let us say, for Loan X the outstanding loan is Rs100cr and the NAV is assessed at Rs55cr. Now 15% of this amount, or Rs8.25cr will be paid by NARCL in cash. For the balance Rs46.75cr, the NARCL will issue Security Receipts. If the final recoverable value of SRs turn out to be only Rs40cr, then the difference of Rs6.75cr will be paid by the government.
This government guarantee comes with 2 conditions. Firstly, it will cover the net shortfall on overall basis, i.e. after adjusting for excess recoveries and limited to Rs30,600cr. Secondly, government will insist on the company going for liquidation before invoking the guarantee. These SRs will be traded in the secondary market, so there will be liquidity and price discovery.
What will be the structure of the Bad Bank system?
One question that arises is about the need for NARCL when there are 28 registered ARCs in India. The NARCL will be like a super ARC for India with the benefit of government guarantee. Here is how the structure will look like.
The NARCL will be the super-ARC registered with RBI and will hold and execute the stressed assets of banks up to Rs2 trillion. NARCL will be 51% owned by PSU banks. The India Debt Resolution Company Ltd (IDRCL will manage the assets of the bank and engage market professionals and turnaround experts, where required. The IDRCL will also do the assessment of the net asset value of the loan, based on which the cash pay-outs will be paid of 15% and security receipts issued of 85%. In this case, PSU banks and DFIs will hold 49%.
How do PSU banks stand to gain from Bad Bank?
The assets move out of the books of banks and also enables them to monetize 15% of the NAV. That improves their cash flows and also return ratios. In addition, the 5 year limit to the government guarantee will force a rapid resolution to the stressed assets. That will also entail freeing up of time, energy and bandwidth of banking staff to focus on deposit and credit growth.
Here is the modus operandi. To begin with, only loan assets above Rs500cr will be taken up and these amount to Rs200,000cr. In Phase 1, Rs90,000cr of assets will be transferred with the balance in Phase 2. This is a bold experiment and if it works, then the Bad Bank will do a world of good to Indian banking system.