Evaluate the recent initiatives done in India to address the problem of bad loans.
There are still around Rs 10 lakh crore worth of stressed assets hanging around in the system. The newly-created National Asset Reconstruction Company (NARCL) in the public sector offers hopes for the faster clean up of lenders’ balance sheets.
About the new structure
- The government of India has established two new firms to acquire stressed assets from banks and then sell them in the market in order to resolve large NPAs (Non-Performing Assets) in the Indian banking sector. Loans or advances that are in default or arrears are classified as nonperforming assets (NPAs).
- NARCL: NARCL was established under the Companies Act and has applied for an Asset Reconstruction Company licence from the Reserve Bank of India (ARC). In various phases, NARCL will buy stressed assets totaling roughly Rs 2 lakh crore from various commercial banks. NARCL will be owned by public sector banks (PSBs) to the tune of 51 percent.
- IDRCL: The stressed assets will subsequently be sold in the market by another firm, India Debt Resolution Company Ltd (IDRCL). IDRCL will be owned to a maximum of 49 percent by PSBs and Public Financial Institutes (FIs). Private-sector lenders will own the remaining 51 percent of the company. The new bad bank structure is the NARCL-IDRCL structure.
- Existing ARCs have aided in the resolution of stressed assets, particularly for loans with lower values.
- The Insolvency and Bankruptcy Code (IBC) and other applicable resolution tools have shown to be useful.
- However, given the massive stock of legacy NPAs, more options/alternatives are required, which is why the NARCL-IRDCL structure was announced in the Union Budget of 2021.
Analysis of measures
- Institutional measures include BIFR (Board for Industrial and Financial Reconstruction, 1987), Lokadalat, DRT (Debt Recovery Tribunal, 1993), CDR (Corporate Debt Restructure, 2001), SARFAESI (Securitisation and Reconstruction of Financial Assets and Enforcement, 2002), ARC (Asset Recovery Company, 2002). But the resolution for these is a measly 6.2 per cent, 4.1 per cent and 26.7 per cent for Lokadalat, DRT and SARFAESI respectively. The RBI has also launched a slew of measures during 2013-14 to resolve, reconstruct and restructure stressed assets. These too did not deliver and they were all abandoned subsequently. The RBI has again come out with a prudential framework for resolution. A poor ecosystem and legal delays frustrate many of these initiatives. These need to be addressed.
- Of the 28 ARCs (private sector) in operation, many are bit players. The top five ARCs account for over 70 per cent of the asset under management (AUM) and nearly 65 per cent of the capital. Either they should consolidate or strategise as niche or regional players. Even private sector ARCs have not done well in the sale of zombie assets. Hardly 13.9 per cent of the assets acquired are actually sold. Financial and business restructuring appears to be more an exception than the norm. Nearly one-third of debts are rescheduled. This is not much value addition to what lenders would have otherwise done at no additional cost.
- The IBC, introduced in 2016, was landmark legislation and marked a welcome departure from the earlier measures, with a legally time-bound resolution. The focus is on resolution rather than recovery. Qualitatively, it has instilled a sense of fear in mischievous corporate borrowers who have siphoned of funds, and dethroned them. It nearly put an end to evergreening. Even though there are delays under this newfound promise, they are counted in terms of days and not years and decades. It has succeeded in resolving a few large corporate borrowers with an average recovery of 45 per cent. But there is concern about the elevated haircuts — in some cases going up to 95 per cent.
- The NCLT (National Company Law Tribunal) proves to be the choke point. It is the backbone of the IBC, but lamentably is starved of infrastructure and over 50 per cent (34 out of 63) of NCLT benches were bereft of regular judges. Over 13,170 cases involving distressed debt of Rs 9.2 lakh crore are languishing with the NCLT. Even the parliamentary committee has rightly expressed indignation on a large number of positions left vacant. This lack of adequate infrastructure, coupled with the poor quality of its decisions, has proved to be the IBC’s Achilles’ heel. We need judicial reforms for early and final resolutions.
- Forty-seven per cent of the cases referred to the IBC, representing over 1,349 cases, have been ordered for liquidation. Over 70 per cent of these cases were languishing at the now-defunct BIFR for years and decades. Against the aggregate claims of the creditors of about Rs 6.9 lakh crore, the liquidation value was estimated at a paltry Rs 0.49 lakh crore. Lenders and regulators need to address this issue of delayed recognition and resolution. Incentives to lenders for more flexible provisioning requirements would encourage them to recognise early. Business stress and/or financial stress needs to be recognised even prior to regulatory norms on NPA classification.
- The tendency to make decisions on the basis of first available information is called “anchoring bias”. The first available information in bidding for distressed assets is the cost of acquisition to ARCs. In the case of the IBC process, it is the liquidation value by IBBI valuers. As per reports, distressed assets that are fully provided for may be taken over by NARCL at 20 per cent. This low cost of acquisition would suffer from the anchor effect and bias. Potential bidders would quote prices nearer to this anchor. This was observed in the IBC bidding process where, in many cases, the quoted prices were close to the liquidation value.
- The IBC has made considerable progress in bringing about behavioural change in errant and wilful defaulters by forbidding them to take back distressed assets. The NARC should uphold this principle, not dilute it. Otherwise, the credit culture suffers. Second, it should have a sunset clause of three to five years. This will avoid the perpetuation of moral hazard and also encourage expeditious resolution. Third, anchor bias needs to be mitigated by better extrinsic value discovery. Fourth, it should avoid selling to other ARCs.
- Nobel Laureate Daniel Kahneman has argued that the anchoring effect may be mitigated by “opposite thinking”. He suggests a three-step process to mitigate anchor bias: One, acknowledge the bias; two, seek more and new sources of information, and three, drop your anchor on the basis of new information
- So long as public sector bank managements are subservient to politicians and bureaucrats, they will continue to lack professionalism, and prudential lending standards will suffer.
- As a result, while having a bad bank is a fine concept, the primary challenge is addressing the underlying structural problems in the banking sector and proposing appropriate adjustments.
How to structure:
- Give an introduction about India’s NPAs and bad loans problem
- Briefly mention how these can affect India
- Now, mention all the recent initiatives
- Present the positives and negatives of these efforts
- Suggest way forward and conclude
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