Budget 2021: India Plans A Bad Bank-Like Structure To Resolve NPAs

The bad bank idea finally takes off.

Indian rupee banknotes of various denominations sit in a cash register. (Photographer: Dhiraj Singh/Bloomberg)
Indian rupee banknotes of various denominations sit in a cash register. (Photographer: Dhiraj Singh/Bloomberg)

The government has proposed a bad bank-like structure to better manage non-performing loans.

An asset reconstruction company and asset management company structure will be set up to take over the bad loans on public sector bank balance sheets and manage recoveries, Finance Minister Nirmala Sitharaman said during her Budget 2021 speech. A similar structure for stressed asset resolution was originally proposed by a committee of bankers under the Sashakt scheme in 2018.

In a post-budget press briefing, Financial Ministry officials said the structure will be set up public and private sector banks.

“Banks will put together initial capital, which will be cash neutral (to the government) into the ARC/AMC,” said Debasis Panda, financial services secretary, indicating that the government will not have a direct stake in the structure.

The structure, according to Sitharaman’s budget speech, will “consolidate and take over the existing stressed debt and then manage and dispose of the assets to Alternate Investment Funds and other potential investors for eventual value realisation”.

A “bad bank” essentially helps banks clean up their balance sheets by transferring their non-performing loans to an entity structured as an asset manager or an asset reconstruction company, potentially helping improve credit flow to the economy.

The idea, discussed and shelved many times in the past few years, is back on the agenda as bad loans could rise from already elevated levels.

While bad loan of Indian lenders mounted in the last few years, the asset quality started improving in FY20. But with the onset of the Covid-19 pandemic, the banking regulator expects this recovery to be short-lived.

Bad loans of Indian banking system could jump sharply by September 2021, according to Reserve Bank of India’s estimates, considering the current macroeconomic climate. Gross bad loans on bank balance sheets could rise to 13.5% by Sept. 30, the regulator said in its latest edition of the Financial Stability Report. That compares with 7.5% in September 2019.

In the worst case scenario, the gross bad loans could rise to 14.8%—the highest in two decades—by the end of the second quarter of financial year 2021-2022.

According to the RBI’s assessment, gross NPAs have been consistently falling over the last two years, with the number at 7.5% in July-September 2020. Even the slippage ratio, the rate of accretion of fresh bad loans, has come down to 0.15% as of September.

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