Bad Bank – Great idea, but the proof of the pudding lies in implementation

download 18 Bad Bank   Great idea, but the proof of the pudding lies in implementation

During the week, the government made the big announcement about formation of Bad Bank. This is likely to be a much-needed measure to resolve the stressed assets problem of the PSU banks.

What will the NARCL do?

National Asset Reconstruction Company or NARCL will also be called Bad Bank. It will take over stressed assets of the banks to the tune of Rs.200,000 crore in face value. The NARCL will be an ARC registered with the RBI, but with the added advantage of guarantee by the government up to Rs.30,600 crore. The NARCL will pay the net asset value of the loan as 15% cash and 85% Security Receipts (SR), with the SRs carrying the government guarantee up to five years.

What will the IDRCL do?

Another important component of this Bad Bank will be Indian Debt Resolution Company (IDRCL). IDRCL will assess the value of the stressed loan, based on the net realizable value (NAV). This NAV will be paid in cash and SRs. In addition, the IDRCL also has another important role. It will take a call on what is needed to turn around the company. That would include appointing turnaround managers as well as getting necessary legal and valuation support. It is the IDRCL which will manage the resolution and do the spade work, based on which the NARCL will eventually disburse the funds. For the banks, it will help monetize assets.

Conditions are too stringent

One concern about the Bad Bank is that the conditions for the government guarantee are a little too stringent. For example, the government guarantee is not on a case-by-case basis but on an overall basis. There will be some cases where the actually realization will be more than the SR value and there will be some cases where the realization will be less than the SR value. Government will first net these amounts and only the net amount is paid as compensation. It is possible that the guarantee may get caught up in liquidity issues. Also, limit of guarantee for five years, is not fair.

Risk of asset undervaluation

The bigger practical risk is that IDRCL may be induced to undervalue the net assets of a company so as to reduce the pressure on the government to pay out the guaranteed amount. In most cases, the valuation may be so conservative that the entire purpose of the Bad Bank may actually get defeated. The second major condition for any compensation under the government guarantee is that the company in question should be first liquidated before the compensation is paid out. That may not be acceptable to the promoters who may want to retain their control over the company. Banks may also use this as a lever to force the companies to liquidate. Overall, Bad Bank may be a good idea, but practical challenges are likely to be too many!

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