Opinion-Banking Sector
Will the NARCL cleanse India’s banking system?
By Amol Agarwal Dt.17th September 2021
A crucial reform for the Indian banking sector was finance minister Nirmala Sitharaman’s proposal to an asset reconstruction company (ARC) and an asset management company (AMC) to resolve the Indian banking sector’s non-performing assets (NPA) problem. This is now moving forward with the establishment of a National Asset Reconstruction Company (NARCL) and India Debt Resolution Company (IDRL) as the AMC serving the NARCL.
Given that we have tried multiple attempts to resolve the NPA problem, why should this one be better? Similar attempts have been made in other countries, with mixed outcomes. But India can learn from these experiences to ensure the success of its attempt to resolve the NPA problem that’s weighing on bank balance sheets.
First, what is an ARC? These specialist companies first buy NPAs from the ailing banks and then repackage these NPAs as securities that are then to investors. In a way the ARCs are like surgeons which remove the clot from the banks and infuse fresh life in banks. The healthier banks can then continue to live a normal life of financial intermediation.
India’s bad loans problem is a decades-old one and there have been multiple structures attempted to resolve it. The ARC idea was first given by the 1998 Narasimham Committee-II which suggested ARCs could be set up by banks in both public and private sector. The earlier 1991 Narasimham Committee – I led to the establishment of Debt Recovery Tribunals and in 1987 we had Lok Adalats. How have they fared? From 2003-17, these three channels were the major source of NPA recovery with ARCs contributing nearly 80% of recovery.
In 2003, the number of ARCs which were two rose to touch 28 in 2019-20. In 2017, the Government enacted the India Bankruptcy code which has not just replaced ARCs on the podium but also led to a significant rise in NPA recovery amounts. In the 2013-18 period, the average recovery was around Rs 35000-38000 crore and jumped nearly five times to Rs 1.7 lakh crore in 2019-20. (Refer RBI Bulletin article for more details).
The question is, given these multiple channels, what is the need for a new government–guaranteed NARCL? These multiple channels can help deal with small recoveries but not large ones. Since 2014, Indian banks have been suffering with gross NPAs touching 11% of gross advances in 2017-18. The situation was improving as the GNPA ratio declined to 7.5% in 2020 but then the Covid-19 pandemic worsened the outlook considerably. The share of large borrowers (LB) in total credit stands at 53% whereas share of LB in GNPA is nearly 80%!
Given this legacy NPA problem, the Government press release mentioned that “additional options/alternatives are needed” which leads to the NARCL-IRDCL structure. NARCL will help resolve bad loans more than Rs 500 crore. The press release mentions that the NARCL plans to acquire stressed assets worth Rs 2 lakh crore which is about 25% of the overall NPA of Rs 8 lakh crore. The NARCL will be funded 15% by cash and 85% by Security Receipts (SR).
The government has also decided to provide guarantees worth Rs 30600 crore of the SR which is 15% of the NARCL balance sheet. The guarantee has been provided to improve credibility and provide for contingency buffers in case of shortfalls in SRs. The guarantee will be valid for 5 years providing both a carrot and stick to the NARCL managers to complete the exercise in the desired time to avail the benefit of the guarantee. The NARCL will buy the bad assets and the management will be done by IDRL. In Phase-I, NARCL/IDRL will resolve bad assets worth Rs 90,000 crore and the remaining Rs 1.1 lakh crore in Phase-II.
Given the above structure and rationale, let us review some global cases on effectiveness of ARCs. In 1992, Sweden established Securum following its crisis which recovered 86 percent of the bad loans and was wound up in 1997. Following South East Asian Crisis, several SE Asian economies established ARCs. Malaysia established Danaharta whose recovery was 58 percent over a 7-year period whereas recovery in South Korea and Indonesia was at 47 percent and 22 percent respectively. The Malysian ARC was government promoted whereas the Korean one used government-promoted bonds. Following the 2008 crisis, Spain and Ireland established their ARCs under public-private partnership. Spain has struggled with losses whereas Ireland has done a much better job.
Global experience shows a mixed record but there have been some broad lessons. First, political will and consensus is central to achieving this clean-up as there could be backlash from all kinds of parties. Second, strong governance and specialized staff are needed to achieve the desired objectives. Needless to say that this is one area which has plagued Indian public sector banks, and should be avoided in this new structure. The government should not engage in political interference and must avoid mission creep. Third, there should be a sunset clause and the NARCL has one for 5 years. Fourth, upfront loss recognition and speedy asset sales help tide over the crisis quickly. The banks might not dispose bad assets if the ARCs buy at inflated prices leading to elongating the crisis and weakening of credit discipline.
There remains the big question is whether the government promoted NARCL/ADRL will finally cleanse the banking system? Without getting into the criticism of whether NARCL is the best option to clean the banking system, we could just focus on trying to ensure its success. The NARCL model has already learnt some global lessons already as pointed above. The key will be execution and if done well, the government and the promoting banks could just remove the NPA cancer from the banking system to a large extent.
Courtesy- Moneycontrol
Will the NARCL cleanse India’s banking system? (moneycontrol.com)