The progress of the National Asset Reconstruction Co (NARCL), established as a state-backed bad bank to address non-performing assets (NPAs) in the Indian banking sector, has encountered significant hurdles. Despite its creation, NARCL has struggled to meet its objectives, with several issues hindering its effectiveness.
The gross non-performing assets in the Indian banking system currently stand at approximately Rs 13 lakh crore, including fully written-off accounts. However, NARCL has struggled to acquire a significant portion of these assets, falling short of expectations.
NARCL fell significantly short of its target to acquire bad loans, purchasing only Rs 10,387 crore of loans from three accounts in FY23, compared to its target of Rs 50,000 crore.
The primary issue plaguing NARCL’s progress is the dual structure of NARCL and IDRCL, which many within NARCL believe is not delivering the expected results. Although IDRCL is engaged in the resolution of distressed assets, NARCL retains ultimate decision-making authority, as it holds the ARC license from the Reserve Bank of India. This dual structure has led to higher costs and unwieldiness, contrary to initial expectations that private sector participation would expedite decision-making in the resolution process.
Moreover, the expiration of central guarantees in 2022-23 has caused further delays in the transfer of bad loans to NARCL. NARCL’s protracted due diligence process and its tendency to present offers that banks consider inadequate have also contributed to the challenges faced by the initiative.
One of the primary challenges faced by NARCL is the bid-offer spread, a common concern in the Asset Reconstruction Company (ARC) industry. ARCs like NARCL typically discount the cost of capital at around 25%, given their expensive capital, while banks, which offload their NPAs to ARCs, discount cash flows at a maximum of 12-13%. This substantial difference in pricing expectations has deterred banks from selling their distressed assets, even when NARCL offers relatively higher prices compared to its peers.
NARCL, a state-backed bad bank formed in 2021, was tasked with acquiring bad loans from banks and selling them to prospective buyers. It was designed to pay up to 15% of the agreed loan value in cash, with the remaining 85% to be paid in government-backed security receipts.
State-owned banks hold a 51% stake in NARCL, while private banks own the remaining stake. Additionally, India Debt Resolution Co (IDRCL), a service company focused on asset resolution, was established to work alongside NARCL. Private banks hold a 51% stake in IDRCL.
Dual structure hurdle
Despite IDRCL’s involvement in resolution activities, NARCL retains ultimate decision-making authority as it holds the ARC license from the Reserve Bank of India (RBI). This setup has led to questions about the need for two separate organizations, potentially resulting in higher costs and a cumbersome structure.
Public-sector ARCs like NARCL, subject to government audit and preferring safer options, may end up incurring higher due diligence costs by paying substantial fees to external consultants compared to private-sector stress asset firms.
NARCL tends to target assets that it believes can be resolved within five years, during which security receipts (SRs) issued by the company enjoy sovereign backing. While this approach may expedite resolution, it may also lead to questions from the government and banks if the realisation from these assets is low.
Initially, the plan for the bad bank was different, with NARCL aggregating assets and operating as a full-fledged ARC, while a sister institution would function as an alternative investment fund (AIF). This AIF would have raised funds from investors with higher risk appetites and infused capital into companies whose debts were acquired by NARCL. However, the RBI rejected this structure, leading to the current dual framework.
While the shortcomings of the twin structure are apparent, there is no immediate plan to integrate or merge the two companies. The challenges faced by NARCL highlight the complexities of addressing NPAs in the Indian banking sector and the need for effective resolution mechanisms.
To enhance NARCL’s effectiveness, experts suggest merging IDRCL with NARCL. This merger would optimize business opportunities, streamline operations, and potentially reduce costs. Additionally, implementing recovery-linked incentives for personnel at the bad bank could attract talent and increase efficiency.
