Tackling the problem of bad loans

News: The newly-created National Asset Reconstruction Company (NARCL), first in the public sector, offers hopes for the faster clean up of lenders’ balance sheets.

NARCL is not a bank, but a specialised financial institution to help resolve the distressed assets of banks.

Over the last 5 years, considerable progress has been made in resolving and recovering bad debts of banks. Despite this, there are still around Rs 10 lakh crore worth of stressed assets in the system.

What are its potential advantages?

Firstly, it will help in the faster aggregation of distressed assets that lie scattered across several lenders.

Secondly, its securitised receipts carry sovereign assurance. It provides comfort to PSU banks as price discovery would not be subject to later investigations.

Thirdly, it would initially focus on large accounts with debts over Rs 500 crore. This is also expected to free the banks from the tortuous recovery process and would provide time to focus on much-needed credit expansion.

What were the previous measures taken to resolve the bad debts?

The RBI had launched a slew of policy measures during 2013-14 to resolve, reconstruct and restructure stressed assets. These measures did not deliver, and they were all abandoned subsequently.

Institutional measures:

-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).

The resolutions undertaken respectively by Lokadalat, DRT, and SARFAESI were merely 6.2%, 4.1%, and 26.7%.

The IBC(Insolvency and Bankruptcy Code, 2016):

With a legally time-bound resolution, rather than recovery, it marked a departure from the earlier measures.

It has instilled a sense of fear in mischievous corporate borrowers who have siphoned funds.

It nearly put an end to ever greening. It has succeeded in resolving a few large corporate borrowers, with an average recovery of 45%.

What are the challenges?

Realisation of debt to lenders-The execution will depend on IDRCL (Indian Debt Resolution Company), the operating arm, which would be in the private sector.

Elevated haircuts(the lower-than-market-value placed on an asset being used as collateral for a loan.) — in some cases going up to 95%.

The NCLT (National Company Law Tribunal) is starved of infrastructure and over 50% of its benches were short of regular judges. This coupled with the poor quality of its decisions has made matters more difficult.

Lenders and regulators need to address this issue of delayed recognition and resolution. Business stress and/or financial stress needs to be recognised even prior to regulatory norms on NPA classification.

Anchoring bias(tendency to make decisions on the basis of first available information)– The low cost of acquisition would suffer from the anchor effect. Potential bidders would quote prices nearer to this anchor.

What needs to be done?

Incentives to lenders for more flexible provisioning requirements would encourage them to recognise bad debts early.

NARC should uphold IBC’s given credit culture principle, not dilute it, by forbidding errant and willful defaulters to take back distressed assets.

-it should have a sunset clause of three to five years. This will avoid the perpetuation of moral hazards and also encourage expeditious resolution.

-Anchor bias needs to be mitigated by better extrinsic value discovery.

-NARC should avoid selling to other ARCs.

The fundamental problem of accumulation of elevated and recurring NPA generation needs to be tackled. Prevention of the accumulation of NPAs (below 2%) is critical.

Source: This post is based on the article “Tackling the problem of bad loans” published in Indian Express on 22 November 2021.