Explanation: the bad bank is ready, how will it solve the stressed assets?

A key proposal announced in this year’s budget (2021), a bad bank to manage stressed assets in the loss-making banking system, has received all regulatory approvals.

What is the structure of the bad bank?

NARCL will acquire and consolidate identified NPA accounts with banks, while IDRCL, under an exclusive agreement, will manage the debt resolution process, State Bank of India Chairman Dinesh said on Friday. Khara, during a press conference.

Padmakumar Nair, Chief Managing Director of SBI’s Stressed Assets Vertical, will lead NARCL, while Manish Makharia, Head of Alternative Investment Fund, SBI Funds Management Pvt Ltd, will lead IDRCL.

Subrata Biswas, the administrator appointed to the NARCL board, will serve as interim chair, and Diwakar Gupta will continue as IDRCL chair.

Khara said that although “some concerns” were raised, NARCL and IDRCL eventually received the required approval. The concerns mainly centered on the dual ownership structure and operational mechanism, with the creation of two separate entities NARCL and IDRCL.

“It’s a structure that was first considered, and whatever time it took, it’s basically ironing out some of the issues that may have arisen in the future. So they’ve all been ironed out and they’ve been dealt with appropriately. And so, that the operation of the two entities is fluid and that they are able to achieve the objective for which they were created,” he said.

Majority owned by public banks, NARCL will be assisted by the India Debt Resolution Company Ltd (IDRCL), itself majority owned by private banks, in a resolution process in the form of a principal relationship -agent.

How will the bad bank work? What is the principal-agent mechanism?

NARCL and IDRCL will have an exclusive agreement which will be in accordance with the scope defined in the “Debt Management Agreement” to be executed between these two entities. This arrangement will be on a “principal-agent” basis and final approvals and ownership of the resolution will rest with NARCL as principal, Khara said.

Although he argued that this was the structure “originally envisaged”, the Association of Indian Banks (IBA) would have wanted a dual structure with the asset management company or AMC as a private entity, out of the scope of regulatory entities.

This would have given it the flexibility required to manage the resolution process, as normally only one entity is responsible as owner and for the recovery of the assets under the asset reconstruction activity. But now, with the “Principal and Agent Mechanism” that has been put in place to address regulatory concerns, final approvals will still be made by NARCL as Principal.

Thus, even though the IDRCL is majority owned by private banks, the final authority will rest with NARCL, which is majority owned by public sector banks. This may have been done to address regulatory concerns about the structure of failing banks.

Finance Minister Nirmala Sitharaman had in her February 1, 2021 budget speech proposed a new structure for the resolution of stressed assets.

“The high level of provisioning by public sector banks of their troubled assets calls for measures to clean up the banking books. An asset reconstruction company and asset management company would be created to consolidate and take over existing distressed debt, then manage and sell the assets to alternative investment funds and other potential investors for eventual realizing value,” she said.

What types of resolutions are expected?

The resolution of the assets will be done gradually. A total of 38 accounts totaling Rs 82,845 crore have been identified to be transferred to NARCL.

In the first phase, at least 15 accounts worth Rs 50,335 crore will be transferred to the proposed bad bank by March 31. Initially, an estimated value of Rs 2 lakh crore of bad assets was to be transferred; however, some of these accounts have already been resolved and more resolutions will occur as referrals to the wrong bank occur.

With a combination of post-Covid moratorium and clawbacks, there was an actual decline in NPAs from Rs 8.40 lakh crore in 2020 to Rs 7.80 lakh crore in 2021.

In a press release, SBI said IDRCL is expected to bring superior resolution techniques, preserve value, enhance brownfield assets, and attract domestic and foreign investors, alternative investment funds, etc. This will free up capital for other bank loans, it said.

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What will the government guarantee?

NARCL will purchase these bad debts through a 15:85 structure, where it will pay 15% of the sale consideration in cash and issue security receipts (SR) for the remaining 85%. The SRs will be guaranteed by the government. The government guarantee will essentially cover the difference between the face value of the security receipts and the realized value of the assets when they are ultimately sold to potential buyers.

The government has approved a 5-year guarantee of up to Rs 30,600 crore for security receipts to be issued by NARCL as non-monetary consideration on the transfer of NPAs. This will address Banks/RBI concerns regarding additional provisioning.

The government guarantee, valid for five years, helps to improve the value of the securities received, their liquidity and their negotiability. A form of contingent liability, the guarantee does not imply any immediate cash outflow for the central government.