Opinion: The creation of a bad bank helps banks but not necessarily the bankrupt

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Opinion: The creation of a bad bank helps banks but not necessarily the bankrupt
BCCL
  • The structure of the bad bank is different from the conventional ARCs wherein the management of the stressed asset and the purchaser of the asset is typically vested with the same entity.
  • While the initial loans being transferred will likely be fully written down loans, the price of acquisition by the NARC and the manner in which the price will be determined is unclear.
  • The sellers are banking on the liquidity of the security receipts, which has a sovereign back stop and therefore betting on likely early realisation.
The finance minister of India has announced the Sovereign Guarantee programme for the security receipts (SRs) issued by the National Asset Reconstruction Company (NARC). Effectively, the amount is approximately 18% of the initial ₹2 lakh crore of non-performing assets (NPAs), which will be transferred to the NARC, mostly by the public sector undertakings (PSUs). The structure of the NARC is different from the conventional ARCs wherein the management of the stressed asset and the purchaser of the asset is typically vested with the same entity. Here, the NARC is effectively a parking vehicle, which will have the licence to issue the SRs and the management of the outcomes of the loans – i.e. the recovery on the SR will be done by a separate asset management company (AMC).

Presumably, the separate asset management company, which will be majority owned by the private sector will have appropriate talent and incentives to maximise the recovery on the SR. The objectives are noble and the sovereign guarantee (subject to certain conditions) is a big step to untangle this knotty problem.

While the initial loans being transferred will likely be fully written down loans, the price of acquisition by the NARC and the manner in which the price will be determined is unclear. Assuming that greater clarity will emerge as we go along, the “India version” of a bad bank addresses several issues with pricing and resolution of such loans.

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The first and most important aspect of this is, it relieves the bankers of “fairness” of the price discovery process and potential post-facto actions, which is a genuine concern of bankers. A sale at a price quoted by NARC won't be questioned later.

The sellers are banking on the liquidity of the security receipts, which has a sovereign back stop and therefore betting on likely early realisation.

A consolidation of the consortium loans in one single decision point is the biggest plus point of the construct. This will reduce delays and friction in decision making with regard to the underlying assets.

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As the sovereign backstop comes with strings attached, it will spur greater urgency in resolution of such assets.

These “controllable” factors, which were a pain point, have been addressed in the new “Bad Bank”; the challenge remains in the systemic issues. Any resolution of these assets would still have to rely upon the existing legal system and processes under IBC [Insolvency and Bankruptcy Code] or Sarfaesi [act]. As we have seen there has been inordinate delays even for admission of cases in National Company Law Tribunal (NCLT).

Notwithstanding the recent Supreme Court admonition to stick to timelines, the NCLTs are not fully equipped to handle the case load. Often they are short staffed and have a frustrating lack of understanding of commercial implications of inordinate delays. It's up to the Govt also to address the issue of enough benches and adequate resources for quicker disposal of cases.

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The second issue is the requirement of additional capital or rescue financing for turning around assets. Earlier ARCs were not permitted to provide additional capital to the defaulters. That does not change with the NARC. Banks were reluctant to provide funds as well if a company is in ARC. That is also unlikely to change. This is a challenge that the asset management company has to overcome.

Finally, the optimism around liquidity of the “sovereign-backed” security has to be tempered with more than a pinch of salt. The conditionality and uncertainty on the outcome of the resolution plans will make price discovery very challenging for investors.

₹1.7 lakh crore of listed tradeable SRs will likely pose a new set of challenges to the Securities and Exchange Board of India (SEBI), with regard to what kind of disclosures should be made to market, who will make such disclosures etc. How will regulations regarding trading basis non public price sensitive information apply to such SRs etc.

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In order for good liquidity, the tax on income earned from security receipts is a grey area particularly for domestic investors and domestic pooled investments like alternative investment funds (AIFs). In fact as it stands it’s a gift to foreign investors! To the detriment of domestic investors.

Any new idea will have to start somewhere, and this is a good start and the rest of the ecosystem will evolve in due course. Hopefully, this will get the banks to focus on credit growth and the NARC will create economic value through revival or recycling of capital as the case may be.



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