Is 'bad bank' a workable solution to PSBs NPA woes?

rupee-reuters Representative image | Reuters

Over the last few years, the biggest problem that has plagued India's banking system is the sharp rise in non-performing assets (NPAs). The challenge has been particularly enormous in the public sector banks. In recent times, the government and regulators have announced various steps, including the Insolvency and Bankruptcy Code, to address the issue. However, with the NPAs only rising, a move to set up a 'bad bank', which could take over the bad loans is now being put forward.

Finance Minister Piyush Goyal has announced that a committee headed by Punjab National Bank chairman Sunil Mehta will study the feasibility of setting up such an asset reconstruction company or a asset management company, which could acquire the bad loans from the state-owned lenders.

The idea of setting up a bad bank is not something new. Such an idea was also mooted in the Economic Survey in 2017-18.

What the survey had recommended was setting up of a centralised Public Sector Asset Rehabilitation Agency (PARA). Chief Economic Advisor Arvind Subramanian had at that time suggested that this agency could buy the bad loans from PSU banks. The banks, which have been weighed down by the NPA problems, could then re-focus on their core activity of lending.

Viral Acharya, deputy governor of Reserve Bank of India, had said if designed right, a bad bank could work. Key to the success would be if the banks would be able to sell the assets to such an entity or an asset reconstruction company (ARC) at the right price.

That idea, however, never took off. Principal Economic Advisor Sanjeev Sanyal had stated in an event that the bad bank would have ended up becoming a “warehouse for dying assets.” Meanwhile, insolvency process was initiated against some of the large NPA accounts and while a few of these accounts have already been resolved and sold, allowing banks to recover some money, many of the other large accounts are in advanced stages of resolutions.

Why is the idea of a centralised bad bank-like agency being mooted now?

Despite various efforts being made to address the issue, NPAs have only risen. According to a study by ratings agency CRISIL, as much as Rs 5 lakh crore worth bad loans deteriorated into NPAs in the year-ended March 2018. Gross NPAs rose to Rs 10.3 lakh crore, or 11.2 per cent of advanced as on March 2018, versus Rs 8 lakh crore or 9.5 per cent of advances as on March 31, 2017.

Already, 11 out of the 21 state-owned banks are under the RBI's prompt corrective action (PCA) watchlist. Under the PCA framework, banks face various restrictions including curbs on lending, branch network expansion, dividends and directors' compensation.

In such a scenario, a centralised entity that could take over the bad loans of these lenders, could indeed be a good idea. However, many questions still remain unanswered.

“While finance minister announced the possibility of formation of an ARC and/or an AMC to take over the stressed assets of PSU banks, the structure and modalities remain unclear,” noted Sameer Bhise of JM Financial Institutional Securities.

The key issue is how the said entity would be funded, he said. There are already a few asset reconstruction companies in the country, and a big challenge has always been about funds to buy bad loans.

“The basic question is how will you fund that ARC or that entity. Where will the government get the funds to acquire the bad assets from banks and at what price will you sell the assets to that entity and who will get into the resolution of those assets,” questioned Karthik Srinivasan, group head of financial sector ratings at ICRA.

Furthermore, what will need to be considered is that banks may still end up taking some hit, given that the ARC or AMC will only buy the bad loan if offered at a bargain price. So, while lenders will recover some of the money, they may not recover all of it.

Srinivasan says that a bad bank was not a solution to the pricing woes of banks. Perhaps, the deals may have to be structured in such a way that the banks would sell the assets at a particular price to the ARC and then post the recovery of the bad loans, the lenders may or may not get some of the upside if any.

The committee, which has been set up to study the feasibility of such an ARC or AMC, has to submit its report in two weeks. It will not only have to study whether such an ARC or AMC is necessary in the first place, but also look at all the key issues like funding and pricing the assets among others.