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Bad Bank to solve Rs 2 lakh crore bad loans, take NPAs off banks’ books; here’s how it will work

Written by Abhinav Garg

Finance Minister Nirmala Sitharaman on Thursday announced that the Union government will guarantee security receipts issued by the National Asset Reconstruction Company for Rs 30,600.

The Bad Bank is finally here, after a decade of speeches. It aims to help clean up the books of banks by taking over bad debts of Rs 2 lakh crore. If it works as expected, Bad Bank can help reduce system-wide bank NPAs (non-performing assets) by more than 1%, and also help collect some bad debts, analysts say. The National Asset Reconstruction Company (NARCL), as it is officially named, will acquire bad debts from banks to settle or liquidate them. He will buy these stressed assets against a mixture of cash and government guaranteed security receipts.

Finance Minister Nirmala Sitharaman announced Thursday that the Union government will guarantee security receipts issued by the National Asset Reconstruction Company (NARCL) for Rs 30,600. “NARCL will acquire stressed assets through a 15% cash payment to banks based on the appraisal and the remaining 85% will be given in the form of security receipts,” said Nirmala Sitharaman. Government guaranteed guarantee receipts can only be invoked in the event of resolution or liquidation.

What is NARCL? Why is this needed?

The National Asset Reconstruction Company (NARCL) was proposed by the Minister of Finance in his speech on the Union budget. NARCL, popularly known as Bad Bank, will operate as an asset rebuilding company set up by banks to resolve stressed assets for smoother operation. Public sector banks will hold 51% of the capital of NARCL. The failing bank intends to resolve stressed loan assets above Rs 500 crore each.

How the Bad Bank will work

Bad debt transfer: NARCL will take over bad debts worth Rs 2 lakh crore from banks, of which Rs 90,000 crore will be included in the first phase. The finance ministry said NARCL will acquire bad loans from banks for a mutually agreed value (naturally, net worth after haircut). NARCL will prepay 15% of the agreed net value of the bad debt in cash and the remaining 85% in the form of collateral receipts. Banks would use this 15% of cash up front to write off the debt write-down. As for the guarantee receipts for the remaining 85%, the bank would reimburse them when the defaulting bank resolves or liquidates the bad debt; or, the bank may also exchange these securities for cash.

Reversal of provision : “These loans are fully provisioned in the books of the bank. The initial cash received, 15% of the depreciated value, would be canceled while provisions for the balance (value of securities receipts) are unlikely to be canceled even if fully provided, ”Kotak Securities analysts wrote in a commentary. note. . “The greatest release of provisions, if any, would be done as cash is received when selling those receipts or redeeming security receipts. The government guarantee on the SRs can allow these securities to be traded, ”added Kotak Securities.

Government guarantee: Security receipts issued by NARCL are backed by a guarantee from the Union government. The state guarantee will cover any difference between the face value of the receipts and the actual realizable value of the bad credit.

Resolution is the key

“The efficiency with which professionals resolve stressed assets needs to be monitored. Arguably the bad bank is likely to become a warehouse for troubled loans without an expected recovery, as it will be difficult to find buyers for legacy assets, ”ICICI Securities said in a note. The resolution of the proposed Rs 2 lakh crore of inherited stressed assets will reduce GNPL (gross non-performing loans) by more than 2%, according to the note. The estimated realizable value of 18% will lead to a reversal of provisioning of Rs 36,000 crore. “With a successful execution of Phase 1, one can expect a short-term NPA reduction of> 1% and NPA recoveries equivalent to 10 basis points of system credit,” said ICICI Securities.

Why is the government guarantee necessary?

The government said resolution mechanisms to deal with a backlog of NPAs generally require support from the government. “It lends credibility and provides buffers for contingencies. Therefore, a government guarantee of up to Rs 30,600 crore will back up security receipts (SRs) issued by NARCL. The warranty will be valid for 5 years. The condition precedent for the invocation of the guarantee would be resolution or liquidation, ”said the Ministry of Finance.

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Abhinav Garg

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