Loan default is a problem that is plaguing the banking sector since time immemorial. While stricter checks on the credit quality of borrowers have been put in place, the industry is still witnessing a rise in the level of NPAs. NPAs or non-performing assets are the technical terms for loans that are bound to or have already defaulted.
The central government has decided to set up a bad bank in India which will be putting this problem to rest. Let’s find out more about what these bad banks are and how they will tackle the issue.
The bad bank in India will be called National Asset Reconstruction Ltd (NARC). This NARC will work as an asset reconstruction company. It will buy bad loans from the banks, thereby relieving them from the NPA. NARC will then attempt to sell the stressed loans to buyers of distressed debt. Distressed debt basically bonds from bankrupt companies. They may also be from companies that are on the verge of bankruptcy.
To sell these stressed assets in the market, the government has already set up India Debt Resolution Company Ltd (IDRCL). IDRCL will attempt to sell them in the market.
The concerned bank, after the stressed asset is sold, will receive the cash for it in parts. If the bad bank in India is not able to sell the stressed loan for a profit or is unable to sell at all, the government guarantee will be invoked. It’s important to note that the government has released a guarantee worth Rs 36,000 crores for this purpose.
SBI chairman Dinesh Khara said on January 28, 2022, that toxic assets worth at least Rs 50,000 crore will be transferred by March 31, 2022. The plan to form a bad bank was introduced in the budget presented in February 2021 however the implementation was delayed.
A total of 38 accounts are supposed to be transferred to Rs 82,845 crore to the NARCL. This will happen in a phased manner. In the first phase, 15 accounts aggregating Rs 50,000 crore will be transferred.
There are too many loans with Indian banks that borrowers have been unable to repay at the end of the agreed tenure. A loan is considered a bank’s asset because the interest you as a borrower pay on it is a form of income for the bank. Once a borrower states that she or he is unable to repay, that particular loan becomes an asset that is not performing anymore, NPA.
Now multiply this situation with the number of banks and the entire borrowing population of India.
According to a statistical resource, government banks in India garnered NPAs worth almost Rs 6.17 lakh crores during the financial year 2021. All the bad bank news claims that NARC is expected to clean up the rising level of NPAs to the highest level possible.
Governments, time after time, have tried to recapitalise banks with fresh capital almost every year but the number of defaults and even high-level scams are on the rise.
A bank with a less burden of NPA would mean better operations for the bank, which in turn may benefit the investors, savers and perhaps even borrowers. But only time can tell if such a mechanism will be helpful in the long run. Key things to watch out for would be if these bad loans will get buyers. If the bad bank does not get a profitable offer for most bad loans, will the government guarantee suffice? If the government extends the guarantee in future, where will the funding for it come from? Hence, once the process starts rolling out, we will have more clarity on if the bad bank system has sailed or not.