Budget, Bad Bank and Chartered Accountants
CA Satheesh & Dr M. S. Raju
CA Satheesh is a member of the Institute. Dr M. S. Raju is Director (Rtd), School of Management and Entrepreneurship, KUFOS, Ernakulam. They can be reached at kvsatheesh@gmail.com and eboard@icai.in.
Performance of banking stocks after the budget was not obscure but rather it was scintillating. Reason for the unassailable upswing in the share prices was due to the announcement of Asset Reconstruction Company (ARC) and Asset Management Company (AMC) for managing the Non-Performing Assets (NPAs) of Public sector banks (PSBs), popularly known as Bad Bank. Later Finance Minister has given some hints that this institution will be guaranteed by Central Government and equity will be raised through a consortium of Public, Private banks, large state owned entities like Rural Electrification Corporation (REC), Power Finance Corporation (PFC) etc.
What Does Bad Bank Mean?
Financial dictionary describes Bad Bank as “A government owned entity that takes over and liquidates toxic assets from failed or declining financial institutions to leave them with a clean balance sheet”. McKinsey observes four basic models of Bad Bank, out of the four, two are internal management proposals like guarantee from Government on part of the portfolio and internal restructuring whereby bank creates a separate dedicated unit to hold and manage the sticky accounts. Two other options have separate existence from that of the parent organization like, bank creates either an independent bank to deal with the delinquent assets or creates a Special Purpose Entity (SPE) which carries the bad books in its portfolio for effective management hence both the external methods are having the characters of a Bad Bank.
Formation and Portfolio of Bad Bank
Bankers estimate that new Bad Bank will have a capital of around Rs 15,000 crores, which could manage bad loans worth of Rs 3 lacs crores from the existing Gross NPAs of Rs 7 lacs cores. ARCs will normally fund only 10-15% upfront for the loans purchased and rest will be issued as Security Receipts (SRs) which would be paid depending on the amount recovered, same operating method might be followed by Bad Bank also. In nutshell Bad Bank acquires the NPAs like Housing, Industrial, Secured and Unsecured etc. from banks and finds out a buyer for decent price and liquidates the same, difference between buying and selling price will be the operating margin or surplus.
Does Bad Bank Differ from ARCs?
Operation style of Bad Bank might be more or less same that of ARCs but Bad Bank will have the advantage of a government guarantee which will directly help in obtaining finance at near to zero risk rates. Apart from advantage on financing cost, a government guaranteed Bad Bank could tap the capital market for initial and subsequent capital requirements. Availability of capital and finance at lower cost will ensure liquidity and Bad Bank will have the capacity to hold the loans for a considerable period of time so that pressure on distress selling at huge haircuts could be avoided. As per the initial hints, Bad Bank will be jointly funded by banks and statutory institutions hence will have a better professional management who have adequate knowledge and experience to deal with large stuck industrial projects and also with niche business ventures.
Will Bad Bank Have Any Added Advantage in Process or Enforceability?
From the discussions, it could be observed that Bad Bank will have a single window type or fast track clearing mechanism and necessary amendments will be made in The Insolvency and Bankruptcy Code, 2016 (IBC), SARFAESI Act, 2002, TDS and Capital gain provisions in the Income Tax Act 1961. Government may constitute special National Company Law Tribunal (NCLT) benches or might give priority to Bad Bank cases in the existing structure itself which will ensure speedy and concreate disposal of cases. A change in the legal system will give considerable confidence to the investors to acquire delinquent assets and a time bound resolution process will keep the organization as an ongoing entity, which could save the employment, creditors and shareholders at large.
What’s the Magnitude of the Situation Which Demands Creation of Bad Bank?
As per the reports from credit rating agency ICRA, Gross NPA of the Scheduled commercial banks (SCB) will move up to 14 -15% of the advances by the end of Mar 2021 from the existing 8.60% clocked during the end of last FY. RBI’s Financial Stability Report, Jul 2020 (RBIFSR) also mentions about an estimated NPA of around 14.70% by end of Mar 21. Lion’s share of the existing NPAs are pocketed by Public sector banks (9.7% for PSBs, 4.6% for private banks (PVB) and 2.5% for foreign banks (FB)) as on end of Sep 20.
If we understand the trend of NPAs in India, we could observe that NPAs have started touching the 5% mark from FY 2015 onwards, a detailed analysis of the reason for such a spike in the year will end up on the structural changes enforced by the RBI in NPA recognition and provisioning requirements. The NPAs which were obscure or managed by the Banks through various types of rescheduling or restructuring methods came to light and from that period and it never went down 5% till closure of FY 20.
A quick decision making on a delinquent account, whether to take any legal recourse or to go for a One Time Settlement (OTS) will have far reaching impact on resolution of the NPAs and this opportunity is substantially or completely not available to PSBs due to the threat of future litigations and existing government regulations. Reasons like excess funding on projects, competitive financing without analyzing the viability of the project, highly leveraged financing or inadequate contribution from promoters, unexpected cost overruns etc. are also solid reasons for existing NPA burden but a time bound recovery efforts will have a better chance of higher realization when compared with delayed decision making.
Figure 1: Comparison of GNPA and NNPA Ratios across Scheduled Commercial Banks (SCBs)
| Bank Category | Gross NPA (GNPA) Ratio (Sep 2020) | Net NPA (NNPA) Ratio (Sep 2020) | Comparative Position |
|---|---|---|---|
| Public Sector Banks (PSBs) | 9.7% | 2.9% | Double GNPA & triple NNPA of private banks |
| Private Banks (PVBs) | 4.6% | 1.0% | Substantially lower delinquency levels |
| Foreign Banks (FBs) | 2.5% | 0.4% | Best performance metrics across SCBs |
| All Scheduled Commercial Banks (SCBs) | 7.5% | 2.1% | Industry-wide average |
Figure 2: Provision Coverage Ratio (PCR) and Capital to Risk-Weighted Assets Ratio (CRAR)
| Parameter | PSBs (Sep 2020) | PVBs (Sep 2020) | Foreign Banks (Sep 2020) | All SCBs (Sep 2020) |
|---|---|---|---|---|
| Provision Coverage Ratio (PCR) | 70.5% | 78.3% | 82.9% | 72.4% |
| Capital Adequacy Ratio (CAR/CRAR) | 13.5% | 18.2% | 18.7% | 15.8% |
Figure 3: Projected GNPA Stress Ratios (Sep 2021 Forecasts)
| Bank Category | Actual (Sep 2020) | Baseline Scenario (Sep 2021) | Severe Stress Scenario (Sep 2021) |
|---|---|---|---|
| Public Sector Banks (PSBs) | 9.7% | 16.2% | 17.6% |
| Private Banks (PVBs) | 4.6% | 7.9% | 8.8% |
| Foreign Banks (FBs) | 2.5% | 5.4% | 7.5% |
| All Scheduled Commercial Banks (SCBs) | 7.5% | 13.5% | 14.8% |
How Do Bad Bank Perform Across the World?
Official concept of Bad Bank was pioneered in Mellon Bank, Pittsburgh, USA in 1988. Post 2007-08 financial crisis many of the European countries adopted different varieties of Bad Banks. Some of the countries who have experienced some forms of Bad Bank in earlier years are Finland (1990), Sweden (1992), France (1994), Austria (2009), UK (2010), Spain (2012), Portugal (2014) etc. Performance analysis of the Bad Bank was remarkable because of multiple reasons like professionalism, Government support or backing, confidence of investors, concentrated efforts, public awareness, fast track clearance and continuous monitoring of the performance, etc.
Asian history of Bad Bank was associated with Indonesian Bank Restructuring Agency (IBRA) in 97-98. India can take inspiration from the successful Korean model of Bad Bank operation. Korea Asset Management Corporation (KAMCO) which has managed sticky assets of around 27% of the GDP and successfully brought down the default ratio from 17% in 1997 to 2.3% in year 2002.
What is the Indian Situation and How Could Bad Bank Help to Overcome This?
If we consider the published GNPAs of major public sector banks for the year ending March 2020:
These ratios are much above the global standard of 5%. So from the existing scenario it is evident that some urgent and oriented efforts should be taken to clean the balance sheet of these banks and to recover from the delinquent accounts at the earliest before the RBIFSR estimated standard loans turns to NPAs. If the existing situation is not tackled on war footing basis, PSBs will not have any room to accommodate the spill over from standard loans and marketability of the assets will be limited because of the pandemic related market situations.
To sum up, considering the post Covid scenario, formation of Bad Bank with backing by the government will enhance the management and recovery of NPAs of PSBs. As observed, support from government, capital contributions and professional management will help to sail through the assessed crisis. Fast tracking of legal mechanism will be a boon for existing ARCs and Bad Banks to taste the success quickly.
Stringent enforceability of punishments should be there for NPAs arising out of funds diversion, fraud and willful mismanagement else Bad Bank will be only a receiving entity and couldn’t do any constructive contribution towards overall management of NPAs. In order to control the NPA menace, accountability should be ensured with lending team also else Bad Bank will only function as a transferee of bad loans without having any ability to contain the further flow into its existing portfolio. Provision for a proper feedback mechanism should be provided in Bad Bank rules so that existing errors could be avoided in future and repeating the lacunas should be dealt seriously.
Critical Questions Bad Bank Rules Must Answer:
- [a] What will be the criteria for transfer of NPAs?
- [b] How the pricing will be done?
- [c] What will be the Standard Operating Procedure?
- [d] How the Government funded and government promoted schemes will be treated?
- [e] Will there be any Equity contribution from the government etc.?
Let’s hope that rules and regulations for the Bad Banks will be published soon and they will get operative quickly and all these questions will be answered.
Role of CA in the Bad Banks and Resolution Process
Chartered Accountant is having the opportunity to be a part in each and every step of resolution process. CAs will get the assignments from Bad Banks, Government, defaulted company, creditors, investors, etc. To highlight a few major areas where CAs may contribute are:
References
- RBI’s Financial Stability Report, Jul 2020 and Jan 21
- Union Budget, 2021-22 and subsequent media discussions.
- Published Annual reports and Investor presentation slides of IDBI Bank, Central Bank of India, UCO Bank and Union Bank of India.