How bad bank model of ARC, AMC would work to manage NPAs

Four years back, the Economic Survey mentioned the need for creation of the Public Sector Asset Rehabilitation Agency (PARA) to solve the twin balance sheet problems of overleveraged companies and bad-loan-encumbered banks.  

Since then, the concept of a bad bank has found mention in various ways. The recent one is the announcement in the budget for creating an ARC (Asset Reconstruction Company) and AMC (Asset Management Company) model to deal with the expected spike in Non-Performing Assets (NPA) post-COVID-19, as indicated in the Financial Stability Report, January 2021 by the Reserve Bank of India (RBI). The concern expressed by the RBI is realistic and the intent of the government needs to be complimented for envisaging a framework to handle it. So far, so good. But let's look at some finer details.

Also Read: Why 'Bad Bank' is a bad idea for India

First, let's understand the problem. NPA is not a standalone problem. It is two-dimensional. It is both a stock at a given time, which we express as Gross NPAs that hog 100% limelight, and the other dimension is flow or accretion. New NPAs are created every year.  

In any NPA table, NPA addition is on the top line and gross NPAs are on the bottom-line (see table below).

Headline Gross NPA is around Rs 9 lakh crore as of March 2020 and everybody is rightly bothered. But does anybody examine the number and see that the addition in the last three years is a whopping around Rs 13 lakh crore and the actual reduction (excluding write off) is within Rs 5 lakh crore only.

So, the problem is not managing outstanding NPAs alone. How to reduce fresh NPA accretion and improve actual reduction in NPAs should bother policymakers equally, if not more. Hopefully, the creation of a new Development Finance Institution (DFI) will help commercial banks move away from infra funding, one of the potential NPA generating areas due to ALM mismatch and different parameters for lending.  

The new Good Bank is a necessary complement to Bad Bank. Issues around enhancing credit underwriting skills, real-time online monitoring of end use of funds across lenders, and sorting out vexed inter-creditor issues, etc., need to be brought to the table for discussion.   

Now on the present ARC, AMC construct part. No details are available in the public domain except for some pronouncements by the Union Finance Minister Nirmala Sitharaman in her budget speech and as appearing in some press meets. It would be a good idea to put together the construct in the public domain and seek feedback from all stakeholders. The existing ARCs need to be a part of the consultative process around the construct, as the man who wears the shoes knows where it pinches.

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The bad bank has worked in some countries with active government involvement. However, one thing is different, they did not have any ARC-like structure in India functioning for nearly two decades now. Unless the 29 number itself has some miracle power, it will have the same fate as 28 existing ARCs.

Agreed, it would be a mega outfit and would have a big advantage in faster debt aggregation, which is the first step in resolution.  

But at the end of the day, it has to resolve the assets. Entry gates are wide open with active government backing, but what about the exit? The resolution framework remains the same. When four out of five cases referred under IBC head for liquidation with an average 5% recovery in liquidation cases, and 4% in DRT recovery, as per the latest RBI data, it is time to introspect.  

Why is the investor/buyer appetite lacking? That is the key question and challenge. The infrastructure around IBC and DRTs needs to be strengthened for optimal results. Just making a mega NPA corporation procure NPAs from banks at a price remunerative to them can only be a pain killer, not the cure.

Also Read: Rebooting Economy 65: IBC has failed; will a bad bank succeed?

The proposed two-tier ARC, AMC framework, ostensibly created with public structure and private sector in mind for the respective entities, may create more problems than they serve. While one acquires at a price, the other has to arrange for a buyer at a price plus be commercially viable. If there is no buyer at the price, each will look at the other distraught. The buck will have no stop.

Wherever a bad bank has succeeded, it is because new money has come in. The new money will only come when there is a hassle-free acquisition, and the valuation offers the investor an attractive return to put his capital at risk. An enabling framework with the right mix of incentives and growth opportunities is a necessary condition.   

A great initiative has been taken by the government. All those driving the process should see that the structure is optimally designed, supports the eco-system, and is developed for value maximisation. The conditions are ripe. India is on the cusp of a new growth story. A vibrant, distressed debt market will revitalise the economy.

(The author is associated with ARC sector. Views are personal.)