Paving the way for a major clean-up of bad loans in the banking system, the Cabinet on Wednesday cleared a ₹30,600-crore guarantee programme for securities to be issued by the newly incorporated ‘bad bank’ for taking over and resolving non-performing assets (NPAs) amounting to ₹2 lakh crore.
The Reserve Bank of India is in the process of granting a licence for the National Asset Reconstruction Company Limited (NARCL) , following which toxic assets worth ₹90,000 crore that banks have already fully provided for, will move to the NARCL, Financial Services Secretary Debashish Panda said.
Finance Minister Nirmala Sitharaman said the Cabinet’s decision to extend a five-year guarantee for NARCL-issued security receipts to banks completed the entire cycle of cleaning up India’s banking system that began with the recognition of the extent of bad loans in 2015.
Under the proposed mechanism, the NARCL will acquire assets by making an offer to the lead bank. Private sector asset reconstruction (ARCs) firms may also be allowed to outbid the NARCL. Separately, public and private lenders will combine forces to set up an India Debt Resolution Company (IDRC) that will manage these assets and try to raise their value for final resolution.
“A 15% cash payment would be made to the banks based on some valuation and the rest will be given as security receipts. For those to hold on and have their value intact, there is a need for the government to give a back-stop arrangement and that is why this ₹30,600 crore has been cleared by the Cabinet,” Ms. Sitharaman said.
Once the NARCL and the IDRC have finally resolved the asset, preferably as a going concern and not through liquidation proceedings, the Minister said the balance 85% held as security receipts would be given to the banks.
“The government back-stop will come in only as much as to pay the gap between the realised value and the face value of those receipts and this will hold good for only five years,” she explained.
While there are 28 ARCs in the private sector, she said they did not take up big ticket resolutions, so a need was felt for government-backed security receipts.
“The whole idea is to ensure that these assets for which this whole set-up is being created, and the value that is locked in the assets is realised and comes back to the banks; they use it as a growth capital and the banking system becomes more robust,” Mr. Panda said.
“In all probability, some assets may have an upside, [and] by using the guarantee as a backstop, the entire upside will also come to the banks rather than getting retained by the NARCL,” the Financial Services Secretary said. The five-year limit on the guarantee, with an increase in the fees charged for the guarantee every year, is an incentive for the resolution process to be completed at the earliest, he added.
“We have addressed the issues facing the banking system in totality that in 2015 was a major challenge for the economy. The twin balance sheet problem which caused a lot of stress … today, we have resolved this in a holistic way. Within those five years, all these [NPAs] will have to be resolved,” Ms. Sitharaman emphasised.
The government guarantee for the proposed security receipts is a positive stepping stone for unlocking stressed assets’ value, said ICRA vice-president in charge of financial sector ratings Anil Gupta.
“The upfront cash payment by the NARCL to banks will immediately be accretive for the profitability and capital of the banks, however the ability of the NARCL to resolve these assets in a time-bound manner will be critical for future provision writeback by banks,” he noted.
J. Sagar Associates’ partner Anish Mashruwala said the bad bank’s success would depend on the implementation and management of the transferred NPAs and it was likely that the government would keep a close eye on the management of the IDRC.
Public sector banks will have a 51% ownership in the NARCL, while their shareholding along with that of public sector financial institutions will be capped at 49% for the IDRC, with private lenders bringing in the rest of the equity capital. Mr. Panda said that about 16 banks, including private players, would put up about ₹6,000 crore as equity for the NARCL.