Markets
Bad bank is here but don't expect a miracle on recoveries
Summary
- The NARCL will buy bad assets from banks and offer 15% upfront cash and 85% security receipts
- The government guarantee will ensure that the recovery rate from bad loans is a minimum 18%
The track record of various bad debt resolution mechanisms in India has been poor to say the least, until the Insolvency and Bankruptcy Code (IBC) was born. IBC has resulted in meaningful resolutions in some cases but has not made waves, much to the dismay of the markets. The National Asset Reconstruction Company Ltd (NARCL) is not likely to change this situation much.
Perhaps the market is wrong in expecting big recoveries for lenders from the NARCL when most asset reconstruction companies have hardly been able to deliver. To that extent, the Nifty Bank index’s rise to a new all-time high on Friday looks overdone. That said, it has some valid support.
Like any other asset reconstruction company, the NARCL will buy bad assets from banks and offer 15% upfront cash and 85% security receipts. What sets it apart is that it is armed with a government guarantee worth ₹30,600 crore. This guarantee, according to analysts at Kotak Institutional Equities, puts the minimum recovery rate at 18% from these loans. This is nowhere close to what the IBC has achieved, but is better than the other routes. Banks will end up transferring the worst of their bad loans to the NARCL. As such, the first tranche of ₹90,000 crore will be predominantly written off accounts.
That brings us to the biggest factor that has been the reason for the dismal recovery rates. The defaulted loans worth ₹2 trillion that are expected to be transferred to the NARCL over five years have high provisions against them.
Moreover, these loans have aged, which makes recovery challenging. Historically, banks have not been able to recover more than 10-15% from written off accounts. With such wet powder, there is no reason to expect fireworks or even a spark from NARCL.
There is also the price of acquisition. Analysts point out that the written off loans have zero book value on the banks’ balance sheet. Putting a price on these loans would be a challenge. The government guarantee mentioned earlier may ensure an 18% minimum recovery but it is not free. Banks will have to pay a fee to the government for it. Adjusted for this, it remains to be seen how much of a recovery banks make.
The argument that the transfer of bad loans will release capital for growth is also weak. This benefit is only to the extent of bad loans that are not fully provided for.
“According to Basel-III guidelines, the risk weight for unsecured bad loans is adjusted for the specific provisions. For secured bad loans, it is adjusted for collateral held by the bank," analysts at Nomura pointed out.
The question that arises is whether there are any benefits at all from NARCL. The bad loan transfer will surely improve ratios across banks optically. Net interest margins may widen and any recovery would be booked as profit.
Analysts at Emkay Global Financial Services Ltd estimated a cash recovery of about ₹5,400 crore. In all probability, earnings estimates of some public sector banks may warrant an upward revision. To that extent, the surge in bank shares is justified.
As a solution to the bad loan problem, the NARCL has come too late as the cycle has already turned. Much like other asset reconstruction companies, the NARCL also risks becoming a mere warehouse of toxic assets and in worse cases just a dump yard.
However, it would result in freeing up the time and effort of banking staff for more meaningful pursuits such as getting more business.
