Union Budget 2021: Exploring the bad bank theory

The proposals to privatise two public sector banks and to set up a quasi bad bank by transferring toxic assets to a holding company and then selling these to AIFs (alternate investment funds) are bold and well worth exploring. Disposing off the banks might turn out to be easier than selling bad loans, the outrage from the trade unions notwithstanding. The logic for selling them is impeccable, there’s little point throwing precious taxpayer money after weak balance sheets and a weakening franchise. A stronger bank can take over the liabilities and use them more efficiently; we need stronger banks to address the credit needs of borrowers.

The likely candidates would be from among those lenders put under the Prompt Corrective Action (PCA) by the regulator a few years back.

The decision to set up an asset reconstruction company (ARC) and asset management company (AMC) to take over existing stressed debt and later dispose these assets to AIF and other investors looks good on paper but might be difficult to execute. The advantage of such a process, as Bahram Vakil, founding partner, AZB & Partners, points out is that the loans can be aggregated. So, rather than the banks working as a consortium, which often delays the process, the combined exposure can be dealt with. As Vakil observes the key to the success lies in the transfer price of the loan from the banks’ books to the AMC.

Equally important would be the skills of the professionals in the AMC who need to turn around the business and enhance the value of the assets.

Experts say the banks must give the professionals a free hand — and the promoters must be asked to leave. “It cannot be Arcil 2.0,” said one veteran banker. Indeed, there will be the initial hiccup of capitalising the holdco. As finance minister Nirmala Sitharaman explained, the holdco will be set up by banks themselves, under the aegis of the IBA and consequently they would need to capitalise it. The finance minister said the government would play a relatively small role, indicating it would not contribute meaningfully to the equity capital.

While the process of an ARC-AMC method might be a transparent one, the fact is banks will recover their money only once the business has been revived successfully and once the AIFs have bought the assets. That could take its time; should a balance sheet restructuring solve the problem, that may be a better way out. For very large exposures, experts reckon the IBC is still the best route to take. Hopefully, the suspension of the law will soon be reversed.