There's been quite a buzz around a national bad bank for India of late, following the release of the Economic Survey 2016-17 on 31 January. The document contains a chapter titled "The Festering Twin Balance Sheet Problem" [of corporates and banks], in which it examines problem of non-performing assets (NPAs) with public sector banks (PSBs), the options available under the current regulatory framework and its limitations to address the issues effectively. It suggests the creation of a Public Sector Assets Rehabilitation Agency (PARA) as a solution to the increasing NPAs of PSBs.
Make no mistake—it is a government bailout package to nurse public sector banks to health.
The Reserve Bank of India, in the post- Monetary Policy Committee meet in February, also concurred with the view that a properly designed bank could be a good solution to the current NPA problems.
Failure of other measures to tackle NPAs
The debate on the intent and content of a bad bank has been there for a while. However, now when stressed loans of banks have reached 16.6%, higher than the peak of 14.7% observed in 1998-99, it cannot be treated as business as usual. While the RBI has been taking lot of measures like SDR, 5:25, S4A and creation of Joint Lenders Forum (JLF) etc, besides encouraging sale of assets to Asset Reconstruction Companies ( ARCs), the desires results have not been seen for various reasons.
Need for a surgical strike, not piecemeal measures
Public sector banks which are owned/ controlled by government are saddled with NPAs. It is unlikely that they will come back to health on their own. What is required now is a surgical strike in shape of direct government intervention—such as PARA, the nomenclature used in the Economic Survey to refer to what is essentially a bad bank.
The broad contours of PARA (which I was call a "bad bank" for the sake of simplicity) are suggested in following paragraphs, covering ownership structure, assets to be acquired, valuation and pricing, resolution framework, participation by investor etc.
Design of a Bad Bank
The Ownership structure
The bad bank will be owned by the government of India. Make no mistake—it is a government bailout package to nurse public sector banks to health. For growth in the economy, credit creation is an essential precondition. Indian banking is dominated by PSBs that are groaning under the weight of NPAs; as of December 2016, credit growth is at a multi-decade low. To kick-start the economy, the government has to take proactive initiative. Most successful bad banks have been in the government sector including the recent Troubled Assets Relief Programme (TARP) by the US Treasury in the most advanced free capital economy, which has already recovered its investments and is making profits.
Management and organisation structure
The bad bank will be divided into sector specific verticals like road, port, and power etc. Each vertical will have industry experts and regulatory heads associated with the sector for advice. The oversight will be done through a distinguished panel representing government, bank, turnaround specialists, insolvency professionals, and lawyers etc. an apex level periodic review may be undertaken at Finance Ministry/ RBI.
Acquisition of assets
The Bad Bank may acquire certain predefined NPAs from PSBs particularly in Infra related projects with cut off outstanding exposure (total indebtedness) Say Rs 1000 crore. Involving more than one PSB. The entire loan facilities of a borrower in all PSBs will be transferred in single go.
Valuation and purchase consideration
One of the key constraints in transfer of assets by banks to ARCs as of now is absence of a generally accepted valuation matrix. Since it may take time to evolve one, the transfer of assets by public sector banks to this government-sponsored bad bank may be at net book value (NBV). After a detailed asset quality review by the RBI, the NBV has become more aligned to the underlying value. The Provision Coverage Ratio is estimated between 60-70%, so the purchase consideration will be 30-40% of the outstanding. With in-built debt aggregation and PSBs combined generally holding >75% of loans, the bad bank can start resolution without any delay and inter-creditor issues—which are biggest hurdles in debt resolution and lead to value erosion. The purchase consideration will be paid in the shape of Security Receipts(SR). However, the big difference here will be that it will be guaranteed for redemption of payment by the government. As it will be guaranteed by the government to the extent of 100%, it will attract zero risk weight, will not require rating under recovery rating scale for periodic NAV declaration as 100% recovery is guaranteed by government and will be held to maturity by the asset-selling PSB at outstanding face value. The periodic recovery from the account will be shared with the sellers after meeting all expenses in ratio of the purchase consideration and seniority of charge, if any till the SRs are deemed.
The focus of the bad bank will generally be to restructure and revive projects and add value to the asset in general and the economy at large.
Gains/ upside in any account will be retained to offset loss from other accounts. At the end of resolution of all assets, gains if any may be kept in a reserve for the public sector banks. Loss, if any, has to be borne by the government.
Debt aggregation in one go will remove the biggest stumbling block in resolution as there will not be delay and differences due to inter-creditor issues. Besides, industry experts and government officials in charge of regulatory clearance (s) of the relevant ministry will be roped in by the bad bank to expedite clearances and help faster turnaround. The focus of the bad bank will generally be to restructure and revive projects and add value to the asset in general and the economy at large. The resolution strategy will be based towards value maximisation from underlying assets on NPV basis.
Entry of investor
The bad bank will encourage investors to enter at various stages of resolution. Bridge loans/ additional funding will be brought in by investors who will have seniority over charge for the new money brought in by them. Banks will be asked to extend running account like CA/CC / non-fund-based facilities on no-liability basis.
The investors will be actively encouraged for buying of assets/ business. At this stage, valuation of assets will be by two sets of agencies—a valuer and a rating agency (that have been associated with assessment of expected recovery in distressed assets since 2007, when Recovery Scale Rating was introduced) and an average of the two will be taken as base value.
Future outgo for bank capitalisation to go down
Hopefully, after a clean-up of bad debts, credit creation and earnings of banks will improve substantially. The capital support required by banks from the government year on year will go down, and dividend payable by banks to the government because of improved performance may neutralise the cash outgo from a bad bank.
Why a bad bank is likely to succeed
- A single government entity will be more competent to take decisions rather than 28 individual PSBs.
- The DNA of borrowers will change when they interact with a government body (rather than a bank).
- Capacity building for a complex workout can be better handled by the government which has regulatory control and has management skillsets in public sector enterprises.
- Foreign investors with both risk capital and risk appetite would be more in a government- led initiative, knowing that regulatory risks would stand considerably mitigated in various stages of resolution, including take outs.
Special statute for bad bank
The bad bank may be created under a special statute, mandating PSBs to transfer these assets in a time-bound one-time period of six-nine months. It will be deemed as a Public Financial Institution (PFI) and have all the empowerment available to an ARC. Since government money is involved, and the seller is government body, it may be clarified that the title of assets passed on to the investor will be without any prior defect and cannot be challenged. The fact of transfer of asset by bank to this government body may be kept beyond the scope of judicial scrutiny.