What is a National Bad Bank and how it will work? – The Economic Times

Clipped from: https://economictimes.indiatimes.com/markets/stocks/news/what-is-a-national-bad-bank-and-how-it-will-work/articleshow/80757961.cms

SynopsisBankers estimate the new ARC will require a capital of at least Rs 15,000 crore as that could enable it to buy bad loans amounting to Rs 3 lakh crore.

In Budget 2021, the government has proposed a national Asset Reconstruction Company (ARC) to buy non-performing assets from banks. How is it going to be structured? Is it the panacea for banks’ ills? What needs to be done to make it a winning proposition?

What is this proposed bad bank?
Under a proposal, which is still being finalised by the government, a new ARC will be formed which will buy NPAs from banks. This company will act like a holding company to an asset management company (AMC) which in turn will try to recover money by selling the NPAs to funds that specialise in distressed assets.

How much money will be required to set up this new ARC?
Bankers estimate the new ARC will require a capital of at least Rs 15,000 crore as that could enable it to buy bad loans amounting to Rs 3 lakh crore.

Is it sufficient?
To some extent it would ease the burden on the banks. The total NPAs as of Sept 2020 were Rs 7 lakh crore, or 7.5 per cent of total bank loans. So, selling Rs 3 lakh crore would free up space for them to lend.

But who gives the capital?
The government says it could guarantee but is not keen on providing full funding to it. Instead, it wants banks to invest in the ARC.

How will the guarantee help?
The ARC would pay 15 per cent cash upfront to banks while issuing Security Receipts (SRs) for 85 per cent which would be paid depending on how much is recovered. The belief is that the government guarantee on these SRs may reduce provision requirements.

Does that solve the problem?
Not at all. It can be an accounting escape for banks, but won’t build trust with investors.

Why would investors have doubts?
Because historically the recovery from bad loans sold to ARCs has been less than 30 per cent of the book value for most of the years. So, analysts would factor in the past record and ascribe value accordingly.

Is there no advantage at all?
Yes, there is. A national bad loan aggregator would consolidate NPAs in one entity and be able to sell to one buyer who would then find it easier to recover overcoming hurdles posed by a consortium of lenders pulling in different directions.

What are the challenges for the new ARC?
There are about 24 ARCs already in existence. How would this differentiate? Of course, government backing will make it easier for public sector banks to dump their NPAs without fear of probes. But can a government provide guarantee to an entity with private shareholding?

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