The bad bank should not be a one-off deal to clean up bank books. Loans will grow, new bad loans will creep in, and banks’ appetite for capital will never end.
From storytellers of Dalal Street to rule-makers in Delhi, everyone is betting on the bad bank to do a good job. Stocks of State-owned banks rose last week, with the largest lender, the State Bank of India (SBI), touching a new high, when Nirmala Sitharaman announced the Rs 30,600 crore government guarantee on security receipts (SRs), or quasi-bonds, the National Asset Reconstruction Co Ltd (NARCL) — the name given to the bad bank — would issue to buy sticky loans from banks. The information, widely anticipated, had been largely factored in by stock traders. Nonetheless, the FM’s reaffirmation was an occasion for investors to buy more shares of public sector banks (PSBs), which house bulk of the bad loans.
The deliberations over the past one year and the subsequent endorsement by GoI have built up an atmosphere of great expectations about the bad bank becoming the final fix for battered banks and nervous bankers. But will it live up to expectations?
Not if its managers fail to escape the hangover from their long stints in State-controlled banks, and continue to be dogged by old fears that haunt CEOs of PSBs well after they retire. Not if they are unable to accept innovative solutions for quicker resolution of bad debts. And, certainly not if bureaucrats with only a sketchy understanding of banking and the stress asset market breathe down their necks.
Such risks exist. PSBs, by regulation, will have a majority control in NARCL, which, besides choosing the loans to buy, may also end up having a big (if not a binding) say on what to do with loans it acquires. The resolution process, however, would be carried out by a separate entity — India Debt Resolution Co Ltd (IDRCL) — in which private sector institutions would hold 51% equity. But it’s unclear whether IDRCL, with majority private ownership, would serve as a mere service company, or be allowed to independently strike deals to turnaround a defaulting company, change the management of a delinquent borrower, dispose of assets, or agree on a loan haircut without the consent and approval of NARCL.
If the resolution arm does not have the liberty and flexibility in choosing the resolution path, there is very little sense in forming a separate private sector company. The success of any asset reconstruction company (ARC) depends on buying loans at the right price from banks and finding a meaningful resolution.
Where the ARC Turns
The bad bank will have an edge over other ARCs. It can use its clout, government backing and comparatively well-capitalised balance-sheet to buy loans from several banks having exposure to a corporate defaulter. This aggregation of loans, which other ARCs often take a long time to complete, would give a certain advantage to NARCL.
Also, PSBs would be less reluctant in dealing with an organisation in which their peers hold a substantial stake and are more willing to accept SRs that are at least partly guaranteed by the government. What comes next is the more difficult job — making the most of the bad loans that are purchased. An ARC can choose multiple avenues to deal with it: settling with the borrower, rescheduling the debts, selling off assets, bringing in new managers or initiating the safer, less controversial (but more time-consuming and not necessarily the optimal solution) of initiating bankruptcy proceedings.
Abulk of the Rs 92,000 crore loans that banks would sell are old non-performing assets (NPAs) that have been fully or adequately provided for by the lenders, and where the value of underlying collaterals like plant, machinery and other assets may have considerably eroded. Resolving such cases would require innovative, even aggressive, solutions that are faster and probably the best, given the specifics in each case. But such solutions would typically elude decision-makers who function within a PSB bubble with all its customary conventions and concerns.
Cutting a deal with the existing management, roping in a private equity investor, offering a higher return to a stress or hedge fund that infuses funds, and raising more debt to bet on a turnaround may not be immediate options for them.
RBI may not readily consider the two entities — a PSU ARC and private sector debt manager — as one platform, or let NARCL outsource executive decisions on resolutions to IDRCL (which, though tagged with an ARC, is not an ARC).
Don’t Replay the Red Tape
Perhaps the regulator should think differently, and take a leap to allow NARCL and IDRCL sign a contractual relationship for meaningful resolutions. Else, the two companies could end up blaming each other when a resolution backfires: with IDRCL pointing fingers at the bad bank for overpaying on loans and the bad bank picking holes in the resolution strategy.
The bad bank should not be a one-off deal to clean up bank books. Loans will grow, new bad loans will creep in, and banks’ appetite for capital will never end. Unless the bad bank gets rid of the PSU trappings and its managers are encouraged to fearlessly go ahead with realistic and optimal resolutions, the wheels will stop moving after a few years. Having finally acknowledged the need for a bad bank, the government should keep it free from bureaucrats.