The success of a bad bank depends on execution

The initial euphoria over the budget announcement by a state bad bank to clean up bank balance sheets and resume credit flow was defeated when the government made it clear that it would not invest in such a company. Bad loans from ₹500 crore and more are eligible for settlement by this company, with an estimated total corpus of ₹2.25 trillion.

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If state banks or domestic institutions invest in the bad bank, the government should identify the leading institutions to move it forward, said Sunil Mehta, non-executive chairman of Yes Bank.

“The governance structure must ensure the ability to act independently. Real pricing at the time of sale is critical and needs to be market driven, “said Mehta, who chaired the Sashakt committee in 2018, which proposed the creation of an asset management company and alternative mutual fund to manage bad loans.

ARCs like Asset Reconstruction Co. India Ltd (Arcil) and Edelweiss ARC buy non-performing loans from banks and collect the loans themselves. In return for the sale of these assets, the banks receive an advance payment of at least 15% in cash, the rest in the form of security receipts that can be redeemed when the loans are repaid.

Public sector banks should collectively own no more than 51% of the bad bank to allow more flexibility, a banking industry veteran said on condition of anonymity. Nevertheless, a bad bank would be more useful to the public banks, as they have had a greater proportion of non-performing loans in the past due to their extensive lending to infrastructure facilities. At the end of September 2020, 9.7% of the loans from public banks were non-performing, compared with 4.6% from private banks and 2.5% from foreign banks.

Aswini Sahoo, Arcil’s chief investment officer, said Feb. 1 that the idea of ​​another ARC could be avoided. The ARC business, he said, has matured in the last 15 years, and leveraging existing physical and intellectual infrastructure to aggregate and resolve bad loans could be time and cost efficient.

“It might be a good idea to capitalize on existing ARCs with long-term capital and guarantees to aggregate the system’s debt and then distribute it to risk-averse investors,” Sahoo said.

Others said existing ARCs would suffer if all loans were taken over by a government-backed bad bank, forcing them to change their operating model. ARCs have been around since the early 2000s and banks use this route to clean up balance sheets. However, according to RBI data, the ratio of the cost of acquiring non-performing loans through the ARCs to the carrying amount of those loans decreased between FY19 and FY20. The central bank noted in its Trend and Progress of Banking in India report that this decline indicates a lower realizable value of assets.

“It is an experiment, the outcome of which will depend on how it is carried out,” said Siby Antony, a former chairwoman of Edelweiss ARC. Antony was also an executive trustee of the Stressed Asset Stabilization Fund, a bad-bank-like structure that the government put into the hive in 2004 to withdraw credit from lenders.