The government will not invest any equity in the bad bank proposed in the Union budget, and commercial banks will have to create and manage it on their own, financial services secretary Debashish Panda said, in contrast to the banks’ proposal for a state-run entity.
A bad bank buys toxic assets from banks and pursues loan recovery on its own, while banks with cleaned-up balance sheets resume lending.
India’s banking system is left with the legacy of bad loans that peaked in 2018, Panda told reporters on Tuesday. “Now, what information we get from banks is that more than ₹2.25 trillion, are still lying unresolved. If these ₹2.25 trillion of bad assets or stressed assets are sold, then the money can be realized, and it can come into banks’ balance sheets,” Panda said, adding that this will help banks lend more and grow.
Bad loan accounts of more than ₹500 crore will be eligible to be transferred to the new entity, Panda said. The bad bank will pay lenders 15% in cash for the loans it purchases, while the rest 85% will be paid as securitized receipts.
“They (banks) will be able to transfer their assets through ARC (asset reconstruction company) at the net book value—the value of assets minus the provisioning that has already been done. In some assets, 100% provisioning has been made, and in some assets, 80% or more has been done. It is not an issue of provisioning, but more about getting the money back from these assets. Otherwise, with the passage of time, there will be erosion in the value of these assets, and there will be no buyer. So, that is the urgency,” Panda said.
He said the initial capital for the bad bank has still to be estimated, but added that a minimum capital of ₹100 crore may suffice.
In May, the Indian Banks Association (IBA) submitted a proposal to the finance ministry and the Reserve Bank of India (RBI) to set up a bad bank to tackle mounting bad loans, which worsened following the covid-19 outbreak.
“An asset reconstruction company and asset management company would be set up to 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 realization,” finance minister Nirmala Sitharaman said in her budget speech on Monday.
A senior banker said lenders are yet to receive a formal plan on how the asset reconstruction company will function and take over assets. “The IBA proposal was for a bad bank backed by the sovereign; however, we can manage with what is being suggested now. A decision has to be taken on the capital allocation strategy, and lenders will meet to discuss it,” the banker said on condition of anonymity.
Another banker at State Bank of India said the capital requirement would not be a problem for banks at the moment, given the amount of gains one would make by transferring bad assets out of the books.
“To my mind, the governance structure of the new entity will be key. It is better if the entity has a private ownership structure. Otherwise one would get into a loop of the three ‘Cs’ of Central Bureau of Investigation (CBI), Comptroller and Auditor General of India (CAG), and Central Vigilance Commission (CVC),” the banker said on condition of anonymity.
Panda also said federal think tank NITI Aayog will identify the two public sector banks and one insurance firm that the budget has proposed to privatize. NITI Aayog’s proposal will be considered by a core group of secretaries, and a final decision will be taken by an alternative mechanism, he said. The alternative mechanism is a ministerial panel, which will decide the bank or insurance firm that will be privatized.
Sitharaman on Monday also announced the creation of a new development finance institution (DFI) to spearhead government spending in infrastructure. This will be regulated by RBI, Panda said. The DFI will initially be capitalized with ₹20,000 crore of government equity, allowing it to leverage debt of up to ₹5 trillion to provide financing to the capital-starved sector.
State-run India Infrastructure Finance Co. Ltd (IIFCL) could be subsumed into this DFI, Panda said.
“IIFCL may be considered for a quick start if it could be subsumed in this new financial institution because they already have some domain expertise and they have some manpower which is already trained and experienced in this field. So, that could be a way of looking at it,” Panda said.