BAD BANK: A CONFOUNDING SAGA

Introduction

There is an old saying, “If you owe the bank a thousand, you have a problem; But if you owe a million, then the bank has a problem.” The whirlwind rise in the NPA’s is the significant reason for historic lows in Public Sector Bank’s credit growth. Therefore, without much ado, the Government has brought new laws, restructured policies, and made amendments to free the banks from NPA’s mounting pressure. The ‘Bad Bank’ is one such modern tool that has attracted the policymakers. As a result of the aftermath of the financial crisis, the concept has been doing rounds in many countries’ corridor; it has recently been boosted since the Economic Survey 2016-17 demanded the establishment of one.

Charles Dickens once said, “A person who can’t pay, gets another person who can’t pay, to guarantee that he can pay.” Similarly, a bank that can’t recover its dues sets up another bank to recover the bad loans. In light of the above confusion, the purpose of Bad Bank almost remains unvocal. Though, it will work only to recover the bad loans. The idea is simple, but where SICA, SARFAESI failed, and there is also a belief that ARC’s and IBC’s can’t do much, there is no case study to support that Bad Bank will surpass all.

The Transitory Timelines

The Government has repeatedly tried to develop various debt reconstruction mechanisms, but it has proved to be a bit of a dud. They are as follows, Firstly, the Strategic Debt Restructuring (SDR) scheme of 2015, which allowed the creditors to convert debt into equity and take over the firms which were unable to pay. Finding a buyer within 18 months of initiating SDR seemed to be one of the reasons for impending closure. Secondly, in the Sustainable Structuring of Stressed Assets (S4A) of 2016, creditors could take a 50% haircut to restore the flow of credit under this scheme. However, one of the significant issues concerning S4A was that banks couldn’t reprice the debt once it was converted into equity. Additionally, the sustainable aspect of the debt was calculated on the basis of current cash flow rather than projection of future cash flows. Thirdly, IBC picked up the steam around the turn of the year 2016. It focused on the resolution or liquidation of indebted firms. But to this date, the debt recovery rate is 20.9% (79% haircut). The plunging recovery rate shows why IBC is far worse than previous debt restructuring mechanisms.

Thus, to resolve NPA’s woes, the Union Budget 2021 came up with the setting of “ARC- AMC Model cum Bad Bank” to recover bad loans. The ARC will acquire bad loans from the banks at a discounted rate, pay 15% upfront cash to the banks, and issue security receipts for the remaining 85%. As per the current model, ARC’s will transfer it to AMC’s who will be ultimately responsible for the recovery of NPA’s. Additionally, AMC will assure to reconstruct and turnaround bad loans and subsequently charge a fee.

However, before delving into another separate ARC, it is essential to verify the existing ones. Asset Reconstruction Companies (ARC) are set up under Section 5 of the SARFAESI Act, 2002. The ARC’s mandate to chip off the NPA’s is to isolate the financial system’s bad loans coupled with facilitation of the financial system by improving the Bank’s balance sheet. However, there are many inadequacies associated with the underlining ARC’s. Firstly, selling NPA’s isn’t an easy task as it is not what banks do regularly. That said, even maintaining the NPA’s till they get sold comes with added cost. Secondly, ARC’s have the same recourse which the banks have, however, the financial Bank will have an edge while dealing because the Bank already knows the borrower in the first place. Thirdly, selling NPA’s require expertise as it is not only financial restructuring but also operational restructuring in some cases. Hence, expertise must be housed in AMC’s. Lastly, any lawsuit or conflict may be attached to the NPAs and so only a handful of buyers come forward. It is important to note that, this new set-up of “ARC-AMC model cum Bad Bank” doesn’t account for the above setbacks. Therefore, Bad Bank is just old wine in the new bottle. In light of the above- mentioned debt mechanisms, Bad Bank’s fate is still riddled with ambiguity.

Scrutinizing the View Point

The first and foremost purpose of the Bad Bank is to segregate the bad loans leaving the Bank with good loans in order to foster the recovery rate of NPAs. Bad loans are not only bad but pure toxic. The whole financial institution starts looking suspicious once bad loans start piling up. Such banks’ stocks will not be favorable as no new investor will ever want to invest money in such institutions. The only option to survive in a competing market is to borrow money from outside investors but can’t mask the exorbitant interest rates. However, such an implication might be far-reaching. When banks are not able to raise capital then disbursing new loans become a difficult task. This, in turn, becomes the banking system’s travesty as the banks cannot perform the primary function of lending and generating income. The root cause of such an issue is the non-recovery from NPAs, but it is still evident that the proposal of “ARC-AMC Model cum Bad Bank” in the budget is more concerned with shifting Bad loans somewhere else consequently, leaving the banks’ balance sheet only with pristine loan. Subsequently, Bank will seize this money-making opportunity by swaying investors and resultantly extending its lending capacity.

Since segregation of loans can increase the Bank’s profitability as it reduces margins for bad loans and focuses more on core lending coupled with reducing the burden on Bank, it will vanish the NPAs altogether. Moreover, there is a possibility of Bad Bank becoming a warehouse for bad loans without substantial recovery. India needs to validate its non-interference-led-markets philosophy as the country wishes to partner with global investors to augment its economic growth; by selling the assets at market price rather than packaging them in different forms to sell them forcibly.

It is observed in a recent Financial stability report by the RBI that gross NPAs of the banking sector is expected to skyrocket from 7.5% in September 2020 to 13.5% in September 2021, the ratio can also escalate to 14.8%. Moreover, Bad loans are not only mushrooming in the Public sector but also NPAs of private banks are as steep as their public sector counterparts. Unfortunately, this new setup proposed in budget FY 2021-22 does not consider NPAs of the private sector a threat. To crown it all, the major issue of acting reluctantly might not be solved as bad banks are in the public sector and this reluctance might shift from public sector banks to bad banks. Whereas if a bad Bank is in the private sector, the public sector banks would be reluctant to sell the loans due to significant haircuts.

To add to it, “Who is the owner of the bad bank?” as currently formulated, a consortium of state-owned and private banks is likely to own the entity. Since the financial budget 2021-22 was tantalizing vague; therefore, the ministry has thrown light on this question that Government will not infuse any equity into bad banks. Additionally, the Government has no substantial guarantee on account of which lenders are seeking a sovereign guarantee for security receipts. There is a possibility that such a move can act as a tranquilizer, but it is not a panacea in the COVID hit economy. The Government’s whole response regarding NPAs in the budget can be phrased as one more stab at attempting to resolve the Bad loans epidemic.

Author’s Take

The dramatic rise in stressed assets in the banking sector of the country is evident. The Government has taken many initiatives to curb the crises of NPA’s; needless to say, it is not efficient to the expected extent. Regarding that the functioning and structure of the proposed Bad Bank are not known. A mere transfer of NPA from one institution to another does not trigger recovery. Without real recovery, the transfer is only superficial and it is just a transfer of the crisis from one institution to another. There is a haircut at the point of transfer, which impacts the banks’ bottom line as writing down a portion is not recovery.

It comes as no surprise that two other unavoidable reasons for failure of different mechanisms are poor bank governance and political interference. It poses the biggest challenge in resolving the NPA’s of Bank. The lack of professional management and independence contributes to many inconsistencies in governance, such as inadequate risk management, bad loan reporting, surveillance and evaluation of bankrupt projects and companies, etc.

To tackle stressed assets, the banking sector needs comprehensive systemic reforms. A trial-and-error approach is not always the best way, as the past and contemporary experiences indicate. The pre-conditions to be met for any process to succeed are twofold; firstly, resolving the problems that contribute to the creation of an unsustainable level of stressed assets and, secondly, to pave the way for effective and successful resolutions. To sum it up, one can safely assume that NPA’s are not like a communicable disease that needs isolation and treatment, all that it requires is proper resolution and governance, it doesn’t need to be quarantined.

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ABOUT THE AUTHOR(S)

Nishtha Shrivastava is a third year law student at Institute of Law, Nirma University, Ahmedabad (Gujarat).

Priyanshi Jain is a third year law student at Institute of Law, Nirma University, Ahmedabad (Gujarat).

In Content Picture Credit: Flickr