Bad Bank Implementation Issues | Nand. L Dhameja

by Prof. Nand. L Dhameja *

The term Bad Bank is a misnomer, it is a bank or a financial institution to bring health to an institution which has gone bad or is having financial problems., It follows a process of writing off or removing distressed assets from the organisation. Many organisations have accumulated losses or carrying on various item which do not have economic value.

UP Government, like other State Governments, waived off Rs. 35,000 crore by way of Kisan Rahat Bonds. In the corporate world, ICICI bank wrote of Rs. 701 crore by spreading it over three years 1997-99; again the Bank took a ‘big bath’ and wrote off Rs. 813 crore in a singe year 2001, to have clear financial position and to show better financial results after merger.

The above instances are one shot instances, where advances not considered recoverable are written off, are treated as losses in profit & Loss Account. This way losses, unhealthy assets are removed from the financial statements of the enterprise. In case of banks such losses termed as Non-Performing Assets (NPA) have mounted-up over the years and reflect poor financial position of banks. For instance, in public sector banks (PSBs) in India NPAs are estimated as 9.7 percent of their advances as on September, 2020 (the corresponding percentages for private banks and foreign banks are 4.5 and 2.5 respectively). these are estimated to shoot-up to 13.5 % in September 2021 as result of the adverse financial and economic conditions due to COVid-19. Such a high percentage of NPAS reflect the poor financial health of banks and adversely affect their capacity to generate revenue as their assets have got depleted.

Similar was the financial position in European countries during financial crises of 2007 -2010. Bad Bank concept became popular with different name, as Assets Restructuring Company (ARC). Bad bank, a financial institution takes over NPAs or distressed assets of banks; relieves the banks from the stressed assets and makes their financial position cleaner and heathier. As such, it isolates illiquid and high-risk assets and accumulates a large portfolio of debts which have unexpected high risk. This way ‘good’ assets are segregated from ‘bad’ assets, Thus, bad bank institution is a special mechanism to deal with the problem of bad assets and to allow the banks to focus on its core business of lending.

To differentiate a bank from bad bank, where bank is a ‘process organization’, while bad bank is a “Project organisation’ having a special skill-set to settle bad assets among a large variety of situations, to settle distress assets at a best possible price at least cost.
Bad Bank concept has advantages as it buys distressed assets from different banks, relieves them the problem of managing and handling such bad debts so that they could concentrate on their core function of accepting deposits and advances. And to concentrate on business expansion. The bad bank uses it special skill set to dispose of bad debts at least cost. However, the bad bank encourages banks to undertake risks and make advances that act as a subsidy to corporation bankruptcy.

Experiences abroad

Number of countries reported to have adopted bad bank concept to ward against rising distressed and corporate loans.

Malaysia after experienced high growth rate 9%+ for a decade before 1997, its NPAs for the banks jumped from 3 % to double digit in a matter of about five years. Assets Management Company (AMC) supported by the government was set up to purchase distressed assets at a price considered to be the market price on the books of the bank.

Similarly, in Sweden, during financial crises in 1992, wherein three of the four major banks were insolvent, two bad banks were established as: a). RETRIVA; b) SECURUM

RETRIVA took over all non-performing loans from banks, while SECURUM took over non-performing loans leaving the good bank operations to continue, and the government. retained a significant equity stake, US Launched Troubled Asset Relief Programme (TARP) in the wake of Lehman Crisis in 2008.

Vietnam adopted a system where bad assets of the public and private banks were transferred to a new structure against bonds which amortized over five years and thus enabled the banks to have adequate capital-adequacy ratio.

In India, as mentioned earlier, where distressed assets have shown increase over the years, this is despite setting up of the Industrial Reconstruction Bank of India (IRBI) which provided term loans and worked out rehabilitation schemes wherein the bad debts were transferred at book value which resulted in moving bad debts from one carpet to another. Further, as per RBI Annual Report on Trends and Progress of Banking in India 2019-20, quality of assets of the banks improved as banks in India wrote off loans to the tune of Rs. 2.37 crore; and merger of thirteen banks into five during 2019-20, has been with the objective to strengthen the banking system.

Idea of bad bank has come up through different agencies;. Indian Bank Association (IBA) proposed the idea to the Finance Ministry and Reserve Bank in 2018; Economic survey suggested bad bank in the form of Public Sector Asset Rehabilitation Agency (PSRA). In addition, Virel Acharya, RBI former Deputy Governor suggested two Assets Management Companies as:

a). Private Assets Management Company (PAMC): for stressed sectors such as metals, infrastructure, and textiles wherein assets have economic value in the short run.
b). National Asset Management Company (NAMC): where the projects are not having economic value, are economically unviable assets, like power companies due to raw material shortages.

Budget 2021 also refers to bad bank: Assets Restructuring Company (ARC), a government company to act as a holding company through Assets Management Company (AMC). ARC would buy NPAs of the banks to the tune of Rs. 3 lakh crore; the payment to be made as 15% cash and 85% in special receipts (SRs) - payments based on the recovery from NPAs. ARC will have a capital of Rs. 15,000 crore and would be able to buy NPAs from banks.

Issues to be considered for setting up of bad bank in India include:

• Who will contribute to the capital of ARC? banks or Government; since there is no provision in the budget; it is likely that the contribution would by consortium of banks.
• As ARC will consolidate the NPAs in one entity and would be able to sell to one buyer who in turn would find it easier to recover the distressed amount, and in case, the recovery is more than the book value, it would be a happy situation to share the surplus, but in what proportion?
• At what price the ARC will buy NPAs? Since provision has already been made for the NPAs by the banks; in many cases, provision is hundred percent, would it be agreeable to the banks to transfer at net value?
• There are already 24 private ARCs; how the government proposed ARC would be different from the existing ones?
• Taxation Aspect:
  • Distressed assets are sold to ARC with a hair-cut, say, a debt of Rs. 500,000 is sold for Rs. Rs. 300,000; would the loss of Rs. 200,000 admissible for tax purposes? In case, there is a surplus or loss on sale of distressed assets,by the ARC, would it be permissible to be adjusted by ARC or by banks.?
  • When ARC disposes off the bad debt, would the difference, whether surplus or deficit, would be permissible to be adjusted by ARC or by the banks which sold the debt?
• Lastly, NPAs arise due to housing loans or industrial loans; housing loans are simple assets for the banks and are generally backed with collateral securities and are valuable, such housing loans are miniscule of total banks loans. Instead, industrial and corporate loans, generally by consortium of banks, are complex. And are a greater proportion of bank advances
• Such Industrial and corporate loans by public sector banks (reported below) involve a greater proportion of NPAS; selling such NPAs to ARC would involve decisions about discounts. Decisions about quantum of discount, in case of private bank or foreign bank would be a matter of judgement by the management; similarly, waving of advances by State Government, as discussed above, could be decided by the Cabinet. Instead, decision about discount for sale to ARC by State Commercial banks would be questionable, and these could be subject to scrutiny by Parliament, Central Vigilance Commission (CVC), or Central Bureau of Investigation (CBI). This raises a big question about the working and success of ARC and bad bank.
• As per RBI, top ten defaulters for bank loans are as:

(Source: RBI as reported in Money and Banking December 14, 2020)

• Further, 264 defaulters having loan of Rs. 100 crore and above each as on June 20, 2020 amounted to Rs. 1.08 lakh crore had the following distribution:

• (Source: RBI reply on RTI by Vivek Velankar)

(Author: Prof. Nand. L Dhameja, Professor and Dean, FMS, Manav Rachna International Institute of Research and Studies, Faridabad) The views expressed are those of the author and not the organization to which he belongs