Rs 31,000-crore support for bad bank: Finance minister Nirmala Sitharaman

© Provided by The Financial Express Some analysts have, however, raised the issue of moral hazard in such guarantees, arguing that it amounts to the government bailing out lenders for their failure in due diligence and, in some cases, complicity with unscrupulous elements.

Finance minister Nirmala Sitharaman on Thursday said the government will offer guarantee to the tune of Rs 30,600 crore on the security receipts (SRs) issued by the National Asset Reconstruction Company (NARCL), or the so-called bad bank, while acquiring non-performing assets from lenders.

While this amount will reflect in the government’s contingent liability, the actual fiscal outgo could be lower if the recovery from the bad assets turns out to be higher than expected.

The guarantee, cleared by the Cabinet, is a decisive step towards the resolution of toxic assets worth Rs 2 lakh crore through the NARCL structure, as sovereign backing is expected to make the entire process a lot more viable and credible.

The guarantee will cover the shortfall between the face value of the SRs and the actual realisation from the stressed assets. It will be valid for five years and can be invoked only in case of resolution or liquidation of the assets. The SRs will be tradable.

“The backstop (guarantee) gives credibility to the process…So, once you take the bad assets out (of banks’ books), manage them, re-evaluate them and put them on the block for sale, there is certainly a greater prospect of getting a higher value for them. That’s why this route has been adopted,” Sitharaman said.

Some analysts have, however, raised the issue of moral hazard in such guarantees, arguing that it amounts to the government bailing out lenders for their failure in due diligence and, in some cases, complicity with unscrupulous elements.

But RBI governor Shaktikanta Das and chief economic adviser KV Subramanian have defended the government’s plan. In an interview to FE in July, Das said even globally, whenever there is a systemic clean-up of bad assets, the sovereign plays an important role. The US government, for instance, came out with the policy of TARP (Troubled Asset Relief Program) after the global financial crisis. What is important, therefore, is to ensure that this ARC framework being put into place is driven by market principles, Das had added.

Though the government is giving guarantee on the SRs, it has not contributed to the equity of the so-called bad bank. In fact, public-sector banks (PSBs) will hold 51% in NARCL. Similarly, the PSBs and public financial institutions will have a 49% stake in the India Debt Resolution Company (IDRCL), which is being set up as an asset management company to work out the NPAs under the overarching NARCL structure, and the rest will be owned by private lenders. As many as 16 banks-both public and private — and some NBFCs have evinced interest in contributing to equity of these entities.

Financial services secretary Debasish Panda said the NARCL is expected to resolve stressed loan assets above Rs 500 crore each amounting to a total of about Rs 2 lakh crore. But in the first phase, fully-provisioned bad assets of about Rs 90,000 crore will likely be transferred. The remaining assets with lower provisions would be transferred in the second phase.

The NARCL will acquire the assets at net book value by offering 15% of them upfront (in cash), and the rest (85%) in SRs. Once the bad loan is resolved, realisation for the relevant bank would be in sync with its SR interest in that asset.

Typically, the NARCL will acquire assets by making an offer to the lead bank. Once its offer is accepted, the IDRCL will then manage the bad loans, add value to them and finally sell them off.

To disincentivise any delay in resolution, the government has stipulated that the NARCL will have to pay it a guarantee fee of 0.25% (of the outstanding guarantees) from the second year of its incorporation. This will then be increased progressively-to 0.5% in the third year, 1%in the fourth year and 2% in the fifth year.

The sovereign guarantee comes at an opportune time. Gross NPA ratio of banks may surge to 9.8% by March 2022, under a baseline scenario, from 7.48% in March 2021, the Reserve Bank of India (RBI) has warned in its Financial Stability Report in July.

Explaining the reason as to why the Centre chose to back the NARCL when 28 private ARCs are already operational, government officials have said they lacked adequate financial and operational muscle to work out large stressed assets of Rs 500 crore or more – the kind of NPAs that will be transferred to the so-called bad bank.

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