Relevance: GS-3: Indian Economy and issues relating to planning, mobilization, of resources, growth, development and employment.

Key Phrases: India Debt Resolution Company, National Asset Reconstruction Company, Bad asset, Bad asset, major bottleneck, Single exclusive entity, Non Performing Asset.

Context:

• Finance Minister recently announced that the National Asset Reconstruction Company (NARCL) along with the India Debt Resolution Company (IDRCL) will take over the first set of bad loans from banks and try to resolve them.

Background:

• The problem of bad loans has been a perennial one in the Indian banking sector.
• The decision to set up a bad bank was taken by the Union government during the Budget presented last year (2021-22) in the aftermath of the nationwide lockdowns, and the moratorium was subsequently extended to borrowers by the Reserve Bank of India (RBI).
• The health of the balance sheets of Indian banks has improved significantly over the last few years with their gross non-performing assets (GNPA) ratio declining from a peak of 11.2% in FY18 to 6.9% in Q2FY22.

What is a ‘bad bank’?

• A bad bank is a financial entity set up to buy Non-Performing Assets (NPAs), or bad loans, from banks.
• After the purchase of a bad loan from a bank, the bad bank may later try to restructure and sell the NPA to investors who might be interested in purchasing it.
• A bad bank makes a profit in its operations if it manages to sell the loan at a price higher than what it paid to acquire the loan from a commercial bank.
• However, generating profits is usually not the primary purpose of a bad bank — the objective is to ease the burden on banks, of holding a large pile of stressed assets, and to get them to lend more actively.

Pros of Bad Bank:

• Ease the burden on banks: The aim of setting up a bad bank is to help ease the burden on banks by taking bad loans off their balance sheets and get them to lend again to customers without constraints.
• Single exclusive entity: A supposed advantage in setting up a bad bank, is that it can help consolidate all bad loans of banks under a single exclusive entity.
• Addresses a major bottleneck: It addresses a major bottleneck to India’s growth over the last few years due to heightened risk aversion in the banking sector.
• Revive credit flow in the economy: Experts believe that by taking bad loans off the books of troubled banks, a bad bank can help free capital of over ₹5 lakh crore that is locked in by banks as provisions against these bad loans.
• This will give banks the freedom to use the freed-up capital to extend more loans to their customers.

Cons of Bad bank:

• Merely shifting bad assets: A bad bank backed by the government will merely shift bad assets from the hands of public sector banks, which are owned by the government, to the hands of a bad bank, which is again owned by the government.
• Pay too much: Unlike a bad bank set up by the private sector, a bad bank backed by the government is likely to pay too much for stressed assets.
• Bad news for taxpayers: It is bad news for taxpayers who will once again have to foot the bill for bailing out troubled banks.
• Lack of commitment: Unlike private banks, which are owned by individuals who have strong financial incentives to manage them well, public sector banks are managed by bureaucrats who may often not have the same commitment to ensuring these lenders’ profitability.

What is National Asset Reconstruction Company Limited (NARCL)?

• The National Asset Reconstruction Company Limited (NARCL) is the name of the asset reconstruction company incorporated, under the Companies Act, as a ‘bad bank’ to help dispose of the stressed assets of the commercial banks.
• Stressed assets of commercial banks worth Rs 2 lakh crore have been identified to be taken up in the first phase by the NARCL.
• NARCL will be starting with a total capital of Rs 6,000 crore.
• In October 2021, NARCL received the RBI’s license to enable it to commence operations as a ‘bad bank’.
• Public Sector Banks (PSBs) have a 51% ownership of NARCL.
• Banks will aggregate and consolidate stressed assets with NARCL for resolution.

What is India Debt Resolution Company Ltd. (IDRCL)? Who has set it up?

• IDRCL is a service company/operational entity which will manage the asset and engage market professionals and turnaround experts.
• Public Sector Banks (PSBs) and Public FIs will hold a maximum of 49% stake and the rest will be with private sector lenders.
• Stressed assets acquired by NARCL will be managed by IDRCL for price discovery and value addition.

How the NARCL-IDRCL works?

• The NARCL will first purchase bad loans from banks.
• It will pay 15% of the agreed price in cash and the remaining 85% will be in the form of “Security Receipts”.
• When the assets are sold , with the help of IDRCL, the commercial banks will be paid back the rest.
• If the bad bank is unable to sell the bad loan, or has to sell it at a loss, then the government guarantee will be invoked and the difference between what the commercial bank was supposed to get and what the bad bank was able to raise will be paid from the money(RS 30600 crore) that has been provided by the government.

Conclusion:

• The structure of the bad bank is conducive for providing a final solution to the banking sector stress and it builds on a series of other reforms that have been initiated since 2015.
• Hopefully, this will culminate the legacy issue of NPAs once and for all and in process it will create a far more resilient, modern and dynamic banking sector.

Sources: The Hindu

Mains Question:

Q. What is a bad bank? How does the piling up of non-performing assets affect the functioning of a bank? (250 Words).