DH Deciphers | Will NARC be the ultimate bad loan recovery agent?

The bad loans crisis in India may finally see some resolution, although it may not be the perfect one. The central government has announced a national-level bad bank that will handle all the debt that lenders have lost hopes of recovering in full. (In the financial year 2020-21, banks' bad loans stood at a whopping Rs 8 lakh crore.) Officially called the National Asset Reconstruction Company (NARC), the bad bank will be run by the central government, and banks that transfer their non-performing assets to it will have shares in it. Banks have already identified Rs 89,000 crore worth of bad loans to be transferred to the NARC. Here’s what a bad bank is and what it does:

Read more: Banks begin process of restructuring of loans up to Rs 25 crore

Why have a bad bank? Can't banks recover the loans on their own?

Despite having enormous resources at their disposal, banks have struggled to recover certain loans, especially those not backed by proper collateral. Think of the now-defunct Kingfisher Airlines and its flamboyant owner Vijay Mallya. The airline had borrowed thousands of crores on Mallya's personal guarantee. As the airline made losses and eventually shut down, banks were left high and dry. In some cases, banks lend money to businesses that keep their projects as collateral. If the project reaches a dead end, there's little that banks can do to recover the money. This is where an Asset Reconstruction Company (ARC) comes into the picture. In addition, selling their bad loans to ARCs helps banks focus on banking activities instead of putting their energy into recovering the debt.

Read | Banks likely to transfer about 80 large NPA accounts to NARCL

How will an ARC recover the loans when banks can't?

An asset reconstruction company does not guarantee loan recovery. What it does is buy bad loans from a bank and try to recover them on its behalf. The ARC's job is to manage assets and charge a management fee for it. The ARC takes possession of the assets of the company (the borrower) and reschedules repayments. If that doesn't work, it can take over the management of the company to ensure that the loans are repaid. As per the rules set by the Reserve Bank of India (RBI), ARCs pay 15% of the value of a bad loan to the bank upfront and the rest via Security Receipts (SRs) and bonds.

Does a bad bank have a deadline for recovering the loans?

ARCs usually get five years to recover a bad loan and an extension if necessary. If these loans are not recovered even then, they are written off (an acknowledgement that the debt will never be repaid). Many cases are resolved between the fourth and the sixth year after the loan has been acquired by the ARC.

How will the NARC help the public-sector banks?

While India does have private ARCs, public-sector banks would prefer resolving bad loans through a state-backed bad bank as they would not have to fear government interference in business transactions. Unlike a private ARC that would have to negotiate with multiple lenders in the case of consortium loans, the NARC would have to deal with only one entity as it is an aggregator of bad loans.

How different is the NARC from the Insolvency and Bankruptcy Code?

An ARC is essentially an asset manager and recovery agent while the Insolvency and Bankruptcy Code (IBC) is one of the tools to recover bad loans. An ARC can use the IBC to recover the bad loans.