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Why the ‘bad bank’ will solve the problem of bankers but not that of banks

The ARC-AMC looks like an attempt to do the impossible, as a distraction away from what really needs to be done  

Published 2 years ago on Feb 18, 2021 16 minutes Read

When there are new arrivals, the old better make room. Not just in fashion retail stores, but even when it comes to bad loans. That probably explains the finance minister Nirmala Sitharaman’s announcement in the Budget to creating an ARC-AMC structure to deal with the mountain of legacy bad loans lying with public sector banks.

From the looks of it, the so-called bad bank is likely to be an entity created by the banks, for the banks and of the banks – the government-owned ones. In a media interaction Debasish Panda, financial services secretary, was quoted as saying that the bank will house legacy NPAs of Rs.2.2 trillion, of which 70 are stressed assets with loan outstanding above Rs.5 billion. These include the defunct or incomplete power plants, EPC players, and several obsolete businesses.

Under the proposed ARC-AMC model, the ARC or the bad bank will aggregate all the stressed assets and transfer the assets to AMC, a skilled and professional asset management company for resolution. The transfer will be at the net book value (NBV). The banks will get 15% cash and 85% security receipts against the bad debt sold to the new ARC. Though there will not be equity infusion from the government, it may provide sovereign guarantee to meet regulatory requirements, Panda was quoted as saying.

What this means is that this super-duper ARC will be capitalised by the same banks that will be selling their bad loans to it. The actual form and substance are not yet clear in terms of who will run such an institution when it comes into being, and if there will be a fixed time by which resolutions must be effected and, more importantly, what kind of superhero the new entity will have to be able to achieve better and faster resolutions once the debt is aggregated. Will this be yet another bureaucratic creation that will try to solve a problem that cannot be solved, and therefore a pretense, while the real problem that needs solving remains untouched?

The government’s bad bank proposal comes on the back of the Sashakt Panel recommendations in July 2018 that as part of a five-pronged resolution for stressed assets included the creation of an AMC-AIF for bad loans of over Rs.5 billion (See: The anatomy of resolution). The idea was to create an AMC-AIF where the participating banks, and other domestic and foreign institutions would invest together to take over assets and achieve operational turnaround. The lead banker would be empowered to run the resolution process wherein the new AMC-AIF will partner with an ARC to jointly bid for an asset in a competitive bidding process and act as a market maker; once the bid is won, the ARC will restructure the asset and pay the banks in cash within 60 days.

To facilitate the process, 35 entities including banks, financial institutions, fund houses and insurance companies have already entered into an inter-creditor agreement (ICA). The Sashakt proposal also included creating a market for distress debt, which has not taken off in India. “All cogs of wheel have to move simultaneously for the whole thing to get moving,” says Sunil Mehta, chairman of the Sashakt Committee and former chairman of PNB. The structure proposed by the government appears to be somewhat similar, but the “devil lies in the details,” Mehta adds.