Behind The Scenes: Why Indias Bad Bank Plan Has Been Thrown Into Turmoil

A last-minute change in strategy, backstage bickering and a lack of direction. After being years in the making, India's plan to set up a bad bank has been thrown into turmoil just months before it was set to become operational.

The National Asset Reconstruction Co., announced formally as part of the budget speech in February 2021, is expected to take over Rs 2 lakh crore worth bad debt, freeing up bank capital tied to these loans. Work on the organisation has been underway since the announcement and it was expected that the first set of transactions by the bad bank would happen before March 31, 2022. The government even agreed to give a guarantee of up to Rs 30,600 crore, in case the NARCL was unable to achieve the planned recovery. Later in October, the Reserve Bank of India gave an ARC license to NARCL to start operations.

But progress has now stalled.

According to three people with direct knowledge of the developments, there is a deadlock at the newly created organisation, with bankers not being able to agree on the next steps. This, after the regulator, in a letter last month, objected to the plan to create an independent debt resolution company under NARCL, which would take over the management and resolution of bad loans. The Reserve Bank of India cited existing norms and declined to make special concessions for structuring the bad bank.

According to the people quoted above, the RBI has cited the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest or SARFAESI Act, as a reason for its objection.

As per existing rules, only ARCs are allowed to implement measures such as change in management, sale of assets and rescheduling of interest, as part of a resolution process. If an independent entity, not licensed by the RBI, is allowed to conduct these activities, it may be in contravention of the Act, the regulator has told lenders, according to the people quoted above.

Emails sent to the RBI and the Indian Banks' Association went unanswered.

Not Many Alternatives

Bankers who were hoping to get a special concession from the RBI on the independent debt resolution company have been left red-faced by the regulator's response.

Larger lenders including State Bank of India and Union Bank of India are working on an alternative strategy for the bad bank. Presently, the only option in front of them is to create a principal-agent structure. This would require NARCL to take a more active role in the resolution process, with the debt resolution company acting as an agent which executes resolution plans approved by the ARC's board.

However, not all lenders are in favour of such a structure.

The idea behind an independent debt resolution company, was complete operational freedom when it comes to recovering money from the underlying accounts.

According to the first person quoted above, the operational freedom would have also meant that the vigilance commission would not question decision-making by the debt resolution company. Without the independent debt resolution company, the NARCL would function the same as the existing ARC industry, the three people quoted above said.

This beats the purpose behind creating a bad bank mechanism, said the first person, an official from a mid-sized public sector bank.

Emails sent to SBI and Union Bank on Friday went unanswered.

Vinayak Bahuguna, former managing director and chief executive officer of Asset Reconstruction Company of India Ltd, though, sees merit in the RBI's objections.

The concept of a multi-layered structure brings about too much complexity without adding much to the outcome, said Bahuguna.

"The incentives are different at different levels of the structure. While one entity is seeking to resolve the asset quickly, the other may want to take more time to earn a higher fee. Moreover, how does one ensure that there are no governance issues, without adequate oversight in place?" Bahuguna said.

Strife Within Bankers

As fresh challenges emerged to the bad bank plan, a blame game between bankers leading the effort followed.

During fiery internal meetings, smaller lenders criticised the expert advisers and large lenders for not being able to foresee the RBI's opposition to the structure proposed or come with a viable alternative, the people said.

Some said the plan was not well thought out to begin with and the objective of creating a structure which would fall outside the purview of vigilance agencies was never going to work.

The recent raids by the tax authorities on certain ARCs have shown that you may create a process which keeps out the vigilance commission, but you cannot avoid government agencies completely, the first person quoted above said. Rather than waste time behind this, they could have focussed on creating a viable structure, this person said.

Smaller lenders have also questioned the decision-making processes being followed at the NARCL. Presently, a core group of the top public sector banks is taking all the calls, while smaller lenders have little or no say in the process.

Expecting Delays

A successful start to the NARCL this year would have meant that banks could start the new financial year on a relatively clean slate. That now looks unlikely.

It also means that a budget pronouncement remains incomplete.

Presently, the RBI's ARC license requires NARCL to start operations by March 31, 2022. Failing this, the regulator will have to extend the deadline by another six months.

While bankers are still hopeful of a breakthrough, the entity will now likely start functioning only in the first quarter of the next financial year, the people quoted above said.

Also Read: NARCL: Bad Bank May Not Move The Needle Much