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Can Bad Bank Yield Goodwill For Lenders?

Author: Dasari Sreenivasa Rao/Thursday, March 4, 2021/Categories: Exclusive

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Can Bad Bank Yield Goodwill For Lenders?

Indian banking sector is suffering from a stressed debt of Rs2.25 lakh crore. Several public-sector banks (PSBs) made huge provisions for bad debts to present window-dressed balance sheets making a clear way for disinvestment or perhaps total privatisation, as the Centre is expecting a better valuation in the due course. Another major block for Bad Bank would be a pricing mechanism for determining sale of bad debt as it involves inter-creditor asymmetry in valuation and divergent security interests. The proposed Bad Bank will help banks extract funds stuck in bad loans. Banking analysts forecast a 25 per cent realisation of bad debt in the process. At this juncture, how effective the proposed Bad Bank in the wake of rising stress in retail loans. According to India Ratings and Research (Ind-Ra) report, the bad loans may rise 170 per cent in 2021-22 financial year. The stress in retail loans may rise to 4.7 per cent by March 2022 from 1.60 per cent in March 2021, forecasts Ind-Ra, a part of Fitch in India.
Jindal Haria, director, Ind-Ra, in the report said: "The private banking sector may witness further rise in stress in retail loans as the stressed loans volume may triple due to their share in unsecured loans. However, the retail sector will add to the credit growth in the banking sector."
Ind-Ra has revised the outlook for the banking sector from negative to stable for FY22. The drop in provisions for corporate loans may stabilise the earnings and support the bottom line, said Ind-Ra. The pragmatic approach and measures by the banks eased Covide-19 caused stress less than the expected level. However, banks are able to strengthen their financial performance by enhancing capital and making provisions. Credit cost in the domestic banking sector declined to two per cent in FY21 from four per cent in FY18. Stressed loans in the corporate sector  reduced to 15.3 per cent of the total loans from 20 per cent in FY18 and this resulted in a decline in credit cost for the banking sector. Ind-Ra forecast 6.9 per cent credit growth in FY21 and 8.9 per cent in FY22 from 1.8 per cent.

What's Bad Bank?
After the Budget-2021, the concept of bad bank is much in focus. The Union Finance Minister Nirmala Sitharaman announced in the Budget that an Asset Reconstruction Company (ARC) and Asset Management Company (AMC) would be established to take care of the stressed debt of Rs2.25 lakh crore in the domestic banking sector. In general the Bad Bank works as a national ARC. Based on the initial proposal, the Bad Bank will run on a two-tier structure. The Centre will have 100 per cent stake with an investment of over Rs10,000 crore. 
The main objectives of setting up bad bank include three factors: To clean the balance sheets of banks in India. To help banks achieve the required level of capital adequacy ratio (CAR), for which banks are allowed  to mobilise fresh capital from the market. Third objective is that a focus on credit growth to boost investment and ultimately economic growth. Bad bank will help the Indian banks cut losses and concentrate on their core business of lending. 
Under the Bad Bank concept, banks are allowed to sell their stressed loans, where they have 75 per cent exposure, to the new institution from existing ARCs in India. about 12 lenders such as Rural electrification Corporation (REC), Power Corporation may take equity in the Bad Bank, which will acquire bad debts of over Rs500crore. In turn, ARC may issue security receipts (SR) backed by the government. RBI will frame new regulations for Bad Bank. 
Nine banks and two non-bank lenders including SBI, PNB, BoB, may infuse Rs7,000crore into Bad Bank. The 11 entities will hold approximately nine per cent stake in Bad Bank. So far, banks are allowed to sell bad debts to ARCs. However, banks are not interested in selling bad debts below the net of provisioning. If 100 per cent provisioning is made, then banks are comfortable to sell off the bad debts to ARCs. 
 
IBA In Action
Indian Banks' Association (IBA) has taken up an exercise to identify bad debts in the banking sector enabling banks to transfer it to the Bad Bank. IBA has asked the banks to list out bad debts measuring over Rs500 crore. Once the data on bad debts is prepared, then there would be a clarity on initial capital requirement for the Bad Bank. IBA in coordination with the Department of Financial Services and few other lenders is working on framing modalities for the proposed Bad Bank. The banks are asked to provide details about bad debts which are nearing resolution under the bankruptcy courts or in liquidation process. Banks need to furnish details about provisioning already made on such bad accounts as well. However, amounts in fraud accounts, unsecured bad loans and equity exposures will be excluded from the list. Anyhow, more or less the proposed Bad Bank will work on the lines of existing ARCs as it was indicated by the RBI Governor. The government has to ensure transfer price is realistic, realisable and market aligned to attract investors and buyers, said a banker. 
 
Rising NPAs In Mudra Loans
The outstanding component of non-performing assets (NPAs) in Pradhan Mantri Mudra Yojana (PMMY) is increasing of late. Particularly among SMEs, the default rate is above the government-guaranteed level. It is estimated that 25 per cent of NPAs may turn into bad debt classification. Generally, banks consider loans to MSMEs are always involved in high risk factors. The risk level further escalated since April 2020 amid coronavirus outbreak. The NDA government in 2015 launched Mudra loans, under which loans upto Rs50,000 are extended to small traders, shopkeepers, vendors, etc., under Shishu scheme, loans upto Rs5lakh to small enterprises and loans upto Rs10 lakhs to handloom weavers, food processing units, etc., under Tarun scheme. 
The total outstanding amount in FY20 was Rs2.67 lakh crore. Banks, NBFCs and micro finance institutions together extended loans under Mudra scheme upto Rs3.29 lakh crore in FY2020. Slippage is going beyond the level guaranteed by the government. 
 
Pvt Banks For Govt-related Biz
With an objective of making the privatisation process more lucrative for investors, the government is contemplating a plan to allow private banks to handle government-related transactions such as taxes, revenues payments, pensions payments, small savings, etc. So far, such activities are being handled by PSBs only. The Centre has already partially allowed banks like HDFC Bank to carry on such transactions in a limited manner. The Centre has also lifted the embargo on private banks to carry out govt-related transactions. After lifting the embargo, the NDA government approached the Reserve Bank of India (RBI) to allow private banks to carry out government businesses. "Allowing private banks will enhance competitiveness and efficiency and customer convenience, said the Union finance Ministry. 
On the other hand, PSBs argue that there wouldn't be a level playing field for banks. "If private banks are allowed, then we would lose our business. Moreover, the social responsibilities of PSBs will be much costlier in the days to come. If PSBs are freed from social responsibility, then we'll also work with a focus on profit margins only," said a CGM of a PSB in Hyderabad.
The implied obligations for enhancing socio-economic conditions about underprivileged sections of the society are being handled by PSBs, which have been entrusted with government-related business transactions that's giving good volumes to the public-sector banks. If private banks are allowed in this space, it'll eat into the margins of PSBs, which will find it difficult to continue social responsibilities in such scenarios. e.g. Jan Dhan accounts don't require minimum balance requirements to maintain the savings account. PSBs have opened about 42 crore Jan Dhan accounts, out of which private banks have only 1.25 crore accounts only. This one example shows what kind of social responsibility the PSBs are fulfilling, remarked the CGM.
 
Privatisations of PSBs
The Centre is actively considering a privatisation move for banks, which are not part of the recent major consolidation drive that amalgamated 12 banks into four banks effective from April 1, 2020, onwards. The number of PSBs in India is now 12 from 27 in 2017. Which means, the Centre may not include SBI, PNB, Canara Bank, BoB in the privatisation list. Hence, the focus is on the two PSBs and one general insurer for privatising them. RBI has already amended Banking Regulation Act and allowed corporate houses to own banks. The Finance Minister has assured that interests of employees would be taken care of. 
 
Sticky loans at a glance
Every industrial vertical or any business has its own risk element and the banking sector is no exception to this. Mounting component of bad debts is because of several reasons including persistent global economic slowdown exacerbated by Covid-19, stalled infrastructure projects coupled with cost overruns, inordinate delay in obtaining various clearances, land acquisition issues, etc.
The gross non-performing assets (GNPAs) in the domestic banking sector were 8.2 per cent (Rs9 lakh crore) in March 2020 as against 9.1 per cent (Rs9.36 lakh crore) on March 31, 2019. In fact, GNPAs of PSBs stood at 10.3 per cent (Rs6.78 lakh crore) as on March 31, 2020, as per Reserve Bank of India’s Trends and Progress Report 2020.
The 2005-12 period witnessed a rapid credit growth. Absence of robust credit appraisal and effective monitoring standards and willful defaults are the major factors for the huge bad loans in the later period. Though the absolute volume of GNPAs of Indian banks marginally reduced mainly due to massive write-offs to the extent of Rs2.38 lakh crore during 2019-20, total restructured standard advances increased from 0.36 per cent to 0.43 per cent as of March 2020 reflecting incipient stress in the sector, observed the RBI in its report.
 The GNPAs could grow further in the absence of the asset quality standstill provided by the RBI as a Covid-19 relief measure. The RBI further stated in its report that the asset quality of the Indian banking system may deteriorate sharply in the near future. To resolve this problem, the Economic Survey came out with a suggestion of recapitalisation of banks along with cleaning of their balance sheets.
The proposed Bad Bank is considered to be better than the existing ARCs as the government will run it. After transferring the NPAs to Bad Bank, PSBs are not required to make higher provisions. This will enable PSBs to mobilise capital from the market. Moreover, discount rates are rising from 30 to 60 per cent of the book value of bad loans due to regulatory norm of upfront cash payment of 15 per cent by ARCs, analysts welcome the proposal of setting up the Bad Bank.
Another problem in the Indian banking sector is that the bank are very slow in selling assets to the ARCs as neither the ARCs nor the banks were willing to put up with the losses amid lengthy process of recovery.
Indian banking sector has been going through a vicious cycle for over a decade owing to several reasons including rising NPAs, higher provisioning, lower capital adequacy ratio and subdued profitability level. This is resulting a sluggish growth in lending capacity which in turn increases NPAs. Banks are focusing on lending only, but not in resolving the increased stressed assets. Banks don't possess the required level of legal expertise nor the conducive environment to recover the NPAs.
Now, banks need to focus on capacity building and re-skilling of their in-house personnel in loan recovery, risk management, etc., in order to stay ahead of the learning curve, advised RBI.
The process of privatising PSBs may result in a sell-off at unattractive valuations. In this scenario, a Bad Bank appears to be a good idea among the available options. The NDA government is advised to enrich Bad Bank with a good business model. So that, the Bad Bank may resolve the twin balance sheet problem in India and capital adequacy ratio concern as well.
The major factor to make Bad Bank a successful concept, NPA valuations should be done by professional or independent institutions.

The writer is a business journalist with 27 years of experience 

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