Bad bank is a bad idea; it's brushing balance sheets under the carpet

Non-performing assets (NPA) is a euphemism for bad debts, that have been the bane of our banks. Its supposed cure — asset reconstruction company (ARC) — is, in turn, a euphemism for bad banks. ‘Sell your NPA to an ARC and clean up your balance sheet’ is the mantra. The government fell for it if only to be seen with the Joneses.

In Budget 2021, Finance Minister Nirmala Sitharaman had announced the formation of India’s first-ever official “Bad Bank”. She said the National Asset Reconstruction Company Ltd (NARCL) has already been incorporated under the Companies Act. It will acquire stressed assets worth about ₹2 lakh-crore from various commercial banks in different phases.  Another entity, India Debt Resolution Company Ltd (IDRCL), which has also been set up, will then try to sell the stressed assets in the market. 

More than a year after the grand announcement, not a single parcel of loan portfolio has been acquired by NARCL.

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Hard bargain by NARCL 

The reluctance to sell NPAs is due to NARCL driving a hard bargain, offering a pitifully low price, presumably slightly above the IBC average recovery of 31 per cent. So, it boils down to this.

“You have piled up an NPA of ₹100 crore. You are struggling to recover it. You are at your wit’s end. Don’t worry, I will buy it for a heavily discounted price of ₹32 crore but I will pay only 15 per cent of this i.e., ₹4.8 crore upfront, and for the balance 85 per cent, I will issue you Security Receipts (SR) and keep on paying you if and when I am able to lay my hands on moolah generated out of recovery of NPAs taken over.”

Would a public sector bank (PSB) fall line hook and silver for a pittance of ₹4.8 crore for every ₹100 crore? Of course, the government has added a sweetener – the Central government stands in readiness with ₹30,600 crore to be used as a guarantee war-chest should there be a shortfall between market realisations and the residual 85 per cent outstandings, but the guarantee is only for five years.

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No one single solution

That the whole idea of bad bank is delusional would be clear from the following:

1. What are the recovery or sale skills in its arsenal that the lending bank itself lacks? Does it have a magic wand?
2. SRs are tradeable on the back of private placement by the bank. It will then start trading like bonds. Where then is the seriousness in recovering the dues from the defaulters given the fact that a vexed commercial bank holding the SRs would be happy to get at least something by unloading them in the market when its patience with the bad bank wears off? 

And, in the process, the bad bank is let off the hook and it can wash its hands of the disagreeable job of recovery though, to be sure, it would have to pay off the holders in due course of the SRs. Once the SR start trading, their prices would start sliding

. Kicking the can down the road is then the most appropriate epithet in this context. Bargain hunters would be active in the market for SRs, to whom redemption of the SRs by NARCL would not be a bad deal. The bottom line is the NPA is ultimately going to be realised at a considerable haircut.

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The dubious potential of ARCs came to the fore last year when Pradip Chaudhuri, the ex-chairman of SBI, was arrested on charges of compromising the interests of his former employer by selling an NPA loan account to Alchemy ARC, which in turn fobbed off SBI with a pittance and parked a good sliver of the recovery in shell accounts. That he got a post-retirement sinecure in Alchemy ARC reinforced this suspicion. 

In other words, the ARC mechanism allows gaming of the system with the defaulter and ARC playing footsie. That was a private sector ARC. NARCL is a government ARC that, while being not dishonest, can be counted upon to be lazy and otherwise inefficient.

The truth is ARC is at best brushing bad debts under the carpet in the name of cleaning up PSB balance-sheets. Indeed, bank loan write-offs followed by recapitalisation have riled critics to no end; they aver that the vicious cycle virtually amounts to throwing good money after bad, hurting taxpayers. 

The NPA monster is to a large extent a fallout of behest lending, as the infamous Kingfisher Airlines bank loan default proves. No one single solution can be touted as the best. Instead, a combination of solutions is possible.

Paradigm changes needed

First, embracing asset-based financing more fully. This is the hallmark of Islamic banking, where the bank, instead of granting a loan, buys the asset needed by the putative borrower under a financial lease arrangement. The borrower cannot demur because he has got what he wanted. Cash at his disposal tantalises him into diversion. Now, that possibility is diminished.

Islamic banking eschews lending (a taboo under Shariat) and therefore embraces lease. Critics call this hypocrisy since the bottom line is lending but the point is the model prevents diversion of borrowed funds for self aggrandisement. Of course, this is not unique to Islamic banking — all asset-based financing including hire purchase and project financing frustrate diversion.

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Second, reverting back to development banks as opposed to the extant universal banking model. The Finance Minister promised this in her budget 2022 speech. Right now, under the universal banking model, asset-liability mismatch (ALM) problem is heaped on the NPA problem in a manner of one reinforcing the other. ALM is a banker’s nightmare when he lends say proceeds of a six-month deposit for a year.

Third, banks focussing only on short- and medium-term loans to small borrowers while forcing big-ticket borrowers to meet their funding requirements from the market. Our listed companies tap the market for equity with alacrity but are shy of doing the same for borrowings knowing that the market is a martinet of a disciplinarian and accords junk status to bonds that have not serviced the bond holders.

Bad banks are a bad joke to the festering problem of bad debts. The RBI must bring about paradigm changes in lending practices by way of vanguard action. ARC is a rearguard action with dubious potential. IBC too is a rearguard action but it at least has one virtue perverse or sadistic though it might be – it ousts the sneering bank loan defaulters from the companies they have founded. But is that what our harried banks want?

(The writer is a CA by qualification, and writes on business, consumer issues and fiscal laws.)

(The Federal seeks to present views and opinions from all sides of the spectrum. The information, ideas or opinions in the articles are of the author and do not necessarily reflect the views of The Federal)