Rationale of Bad Bank for Needo-banking in Indian Economy Mayank Goel* & Professor M.M. Goel*

Professor Dr. M.M. Goel
Mayank Goel

(Asian independent) To cope up with the growing distress caused by the bad loans and clean out the banking system, we needed an institution as Bad Bank for Needo-banking and rectify lending mistakes by adopting the needonomics school of thought in the Indian economy.

Bank means the trust among the depositors for earning interest on their savings, assessing the quality of borrowers before lending and handling routine collections. We sadly failed and created a crisis of non-performing assets (NPA) of huge dimension. The instability in the financial system by lending mistakes called for the bad bank. Funding squeeze created uncertainties that have to be monitored with alertness, awakening and awareness. Bankrupt lenders resulted in dropping credit availability and slowed down the Indian economy with stress in the banking system.

The structure of the bad bank is conducive for providing a final solution to the banking sector stress and it builds on a series of other reforms that have been initiated since 2015. Hopefully, this will culminate the legacy issue of NPAs once and for all and in process, it will create a far more resilient, modern and dynamic Indian banking sector.

Keeping in mind the total factor productivity growth of India in 2019 as 0.43 per cent while that of China was 2.8 per cent. If we look at labour productivity measured as output per hour per labour employed in the economy, China has roughly 1.5 times our productivity levels. Therefore, there is significant scope to improve our productivity levels, which will enhance growth. This is precisely why the present set of reforms initiated by the government are exciting and can usher in a period of prolonged and sustained high levels of economic growth aided by strong macroeconomic fundamentals.

It has to be noted that banks with high levels of bad loans are still getting deposits due to the backup by the Government.  The writing off bad loans is no longer a get out of jail free on the transfer of assets. According to Section 29A of the Insolvency and Bankruptcy Code makes it impossible for promoters of defaulting firms to get their assets back.  The written of the loan value to zero has a value of assets including machinery in the factory, real-estate, customers and suppliers and above all employees have to understand, analysed and interpreted. To enhance the productive capacity in the economy, we have to use this potential with funding. To consolidate and accelerate the recovery of bad loans amounting to Rs 2 Lakh crore ( 1 per cent of GDP), the creation of National Asset Reconstruction Company Limited (NARCL) was announced in the Budget 2021-22 and has been operationalized.

The bad loans have been taken over at 18 per cent of loan value on average with security receipt by NARCL, partly guaranteed by the Government. The proceeds can be written back as profits which will enhance the book value of Public Sector Banks without any dilution of current shareholders. The implication of higher book value is growing loans in the future is to be seen with a positive mindset.

It is also important to understand that movement of assets from the balance sheets of banks does not mean that the money owed will not be recovered — the mechanism is such that the bad bank will pay the banks and purchase these NPAs while it works on recovering the money that is owed to the banks.

In the past, similar structures have been explored, and in most cases, the asset reconstruction companies (ARC) ended up making money — in this case, since 51 per cent of ownership is with PSBs, even if they take a haircut on their balance-sheets, they can expect capital gains through their ownership of the ARC. Ultimately, it may well be the case that this may reduce overall haircuts further and improve the recovery process in the event of efficient functioning of the institution.

Given that criticality in terms of operational efficiency, the structure of the entity becomes relevant. The National Asset Reconstruction Company Limited (NARCL) will acquire assets from various banks, the India Debt Resolution Company Ltd (IDRCL) will be responsible for the management of these assets and 51 per cent of the ownership will be with public sector banks while the rest will come from the private sector — and the contingency buffers offered by the government in the form of guarantee of Rs 30,600 crore worth of Security Receipts (SR) issued by NARCL become crucial.

The guarantee is provided for five years, and it will reduce the need for upfront capitalisation of the new entity as the SR will cover the gaps between the value of SR and the actual realisation. This will also improve liquidity in the market for SRs which is essential for proactive resolution of stressed assets.

We have to wait and watch the quality of execution of Bad Bank with a clean slate of book value of bad loans. The role of professionals with motivation and enthusiasm with 49 per cent in India Debt Resolution Company Limited (IDRCL) and 51 per cent of NARCL are a ray of hope for the specialised operation of a bad bank.

The challenge of coordination among a large number of lenders to a large number of defaulter companies to bring down recovery amount needed consensus on the steps to be taken. We have noted that earlier the recovery of bad loans has been taken care with the specialised department in banks.

The implications of bad bank are more for banks and their shareholders rather than depositors – although a systemically healthy bank is in the interest of depositors. But, in the context of India, its institutions have always managed to preserve the interests of Indian shareholders over the last few decades. For the shareholders, they can expect a lot of stuck capital of the banks getting unlocked as they get an upfront payment post transfer of NPAs. This will also result in a better focus on lending which will add to the overall growth of the bank and its balance sheets. As far as depositors are concerned, the biggest implication now will be that banks will have more bandwidth to deal with their credit requirements – be it for a new home or for a new car

Commercial banks are saddled with high NPA levels, setting up of the Bad bank will help. That’s because such a bank will get rid of all its toxic assets, which were reducing its profits, in one quick move. When the recovery money is paid back, it will further improve the bank’s position. Meanwhile, it can start lending again.

To stop the influence in decision making by the defaulting companies, we need a banking system that can be relied upon by the stakeholders of the Indian economy. We have to create a conducive environment in the banking sector with street SMART ( simple, moral, action-oriented, responsive and transparent) governance at all levels of operation of bad bank necessary for needo-banking in present times.

* The first writer is working as a Corporate Banker in Kotak Mohindra, Delhi.

** The second writer is Vice-Chancellor Starex University Gurugram and Founder Needonomics School of Thought