finance
In the Union Budget for FY 2021-2022, Finance Minister Nirmala Sitharaman announced the creation of an Asset Reconstruction Company Limited (ARC) and an Asset Management Company (AMC) to manage the stressed assets of public sector banks. Consequently, the National Asset Reconstruction Company Ltd (NARCL), a government-backed Bad Bank, alongside the India Debt Resolution Company Ltd (IDRCL), was established.
What are NPAs? Non-Performing Assets (NPA) refers to loans or advances that are overdue for more than 90 days, as defined by the Reserve Bank of India (RBI). An asset is classified as non-performing when it stops generating income for the bank. The 90-day norm for identifying NPAs has been effective from the fiscal year ending March 31, 2004, aligning with international standards.
The classification of NPAs varies based on the duration they remain non-performing:
Sub-Standard Assets: Classified as NPAs for 12 months or less.
Doubtful Assets: Classified as NPAs for more than 12 months.
Loss Assets: Assets deemed “uncollectible” or with minimal value, making them unsuitable as bankable assets, although some recovery value may still exist.
Notable sectors facing major defaults include Steel, Textiles, Infrastructure, and Real Estate. These firms' assets often need disposal, posing challenges in a slowing economy.
The accumulation of bad loans surged between 2006 and 2008 during a period of economic growth and easy borrowing. The global financial crisis of 2007-2008, while leaving India relatively unaffected, led to a decline in investment enthusiasm.
To address chronic NPAs or toxic assets, several legal provisions and frameworks are in place, including:
Insolvency and Bankruptcy Code (IBC)
Securitization and Reconstruction of Financial Assets and Enforcement of Securities Interest (SARFAESI Act)
Debt Recovery Tribunals (DRT)
Additionally, dedicated Stressed Asset Management Verticals (SAMVs) have been established within banks for managing large-value NPA accounts.
Despite these efforts, banks still retain a significant amount of NPAs due to the fragmented nature of bad loans across lenders. The high levels of provisioning against legacy NPAs present an opportunity for expedited resolution.
Although existing ARCs (around 28) have effectively managed smaller loans, the magnitude of legacy NPAs necessitates additional alternative solutions, leading to the introduction of the NARCL-IRDCL structure during the Union Budget announcement.
NARCL has been registered under the Companies Act and has sought a license as an ARC from the Reserve Bank of India. It was formed by banks to aggregate and resolve stressed assets, maintaining 51% ownership in the entity:
Together, these public sector banks represent a total of 51.07% stake in NARCL.
About 16 public and private sector banks invested between Rs 5,000 crore and Rs 6,000 crore into the Bad Bank, which will facilitate payment of 15% cash to lenders when purchasing their bad loans. The remaining 85% will be paid through government-backed security receipts.
The objective of NARCL is to recover between Rs 50,000 crore and Rs 64,000 crore from resolving bad loans valued at Rs 2 trillion, targeting Rs 90,000 crore in Phase 1 and Rs 110,000 crore in Phase.
Should NARCL recover funds from these bad loans, it will benefit the banks involved by enhancing their bottom line. Since NARCL will acquire fully provisioned loans at a significant discount (80-90%) from their initial value, it will pay banks an upfront amount of 15% and the balance via Security Receipts (SRs) issued when recoveries occur. The government is prepared to cover shortfalls between the value of these SRs and actual recoveries up to ₹30,600 crore (15% of Rs 200,000 crore).
IDRCL, a service entity, will oversee asset management and engage professionals for recovery processes. Public Sector Banks and Financial Institutions will retain a maximum of 49% stake, with the remainder held by private lenders.
One of the Public Sector Banks has written off nearly Rs 22,000 crore. Following Bad Bank principles, they would transfer these assets to NARCL for Rs 2,200 crore, receiving Rs 330 crore upfront and the remainder in Security Receipts. However, questions arise regarding potential recoveries exceeding Rs 2,200 crore and whether the respective PSU will benefit or pursue recovery independently. Additionally, uncertainties about the operational timeline for NARCL-IDRCL remain pertinent.
Interestingly, experiences from Mellon Bank suggest potential for positive outcomes before eventual winding down in 1995. The NARCL initiative is a chance to explore similar results in a contemporary context, fostering optimism for future resolutions.