Introduction of bad bank can make existing ARCs more effective: RBI paper

Mumbai: Introduction of a bad bank may help "shape the operations" of the existing asset reconstruction companies (ARCs), an RBI paper said on Monday, noting that a sizable bulk of assets bought by such entities have not been resolved for a long time.

The paper, published in the central bank's monthly bulletin for April, also flagged risks of an excessive reliance on banks by the ARC industry.

It said banks supply non performing assets (NPAs) to the ARCs, hold shareholding in these entities and also lend to them, which makes it necessary to monitor if there is a "circuitous movement of funds between banks and these institutions (ARCs)".

In her Budget speech for FY22, Finance Minister Nirmala Sitharaman had declared that a new ARC will be created to hold the sour assets of the state-run lenders and resolve such assets professionally.

"About 42 per cent of the outstanding SRs (security receipts) as on March 2020 were more than five years of age and would have to be redeemed over the next four years to avoid write-offs," the paper said, pointing out at the difficulties being faced by the current set of ARCs in resolving the stress.

While resolving a case, ARCs pay a minor portion in cash to the selling bank while the rest is SRs to be paid over a time.

"Going forward, the introduction of a new asset reconstruction company for addressing the NPAs of public sector banks may also shape the operations of the existing ARCs," the RBI paper said.

It added that there is a definite scope for the entry of a "well-capitalised and well-designed entity" in the Indian ARC industry and such a body will strengthen the asset resolution mechanism further.

It cited global experiences to lay down the necessary features of the new ARC announced by the government.

It advocated that the new ARC or the bad bank should have a narrow mandate such as resolving NPAs with clearly defined goals, a sunset clause defining their lifespan, supportive legal infrastructure involving bankruptcy and private property laws, backing of a strong political will to recognise problem loans, and a commercial focus including in governance, transparency, and disclosure requirements.

The paper said while proactive asset recognition is important for a correct assessment of the health of the banking system, it needs to be followed by effective asset resolution and recovery by banks.

The absence of an effective resolution and recovery mechanism can discourage recognition of NPAs by banks in the first place. The lack of recourse to timely recovery can also deteriorate the economic value of assets adding to the losses incurred by banks over time, it said.

The regulatory changes by the Reserve Bank have been broadly geared towards strengthening the ARC industry, ensuring genuine sale of NPAs by banks, enhancing the involvement of ARCs in the process of resolution and deepening the market for SRs, it said.

However, it noted that there has been a concentration in the industry in terms of AUM and SRs issued, and net owned funds.

Secondly, despite the regulatory push to broaden, and thereby enhance, the capital base of these companies, they have remained reliant primarily on domestic sources of capital, particularly banks.

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