TO ENSURE THAT the ‘bad bank’ mechanism proposed in the Budget takes off, the Ministry of Finance plans to provide a guarantee against the security receipts that the Asset Reconstruction Company (ARC) will issue to banks against the value of their assets bad debts that are being taken over.
The ARC, according to government officials, is likely to take over between Rs 2 to 2.5 million lakh crore of stressed assets that remain unresolved on around 70 major accounts. Stressed loan accounts of more than Rs 500 million each are expected to be transferred to the new entity.
“Although there will be no capital contribution from the government in the proposed ARC, the government will provide guarantees to ensure the success of this structure,” said a senior government official. The proposed ARC will provide banks with 15 percent cash and 85 percent security receipts against the value of bad assets to be taken from banks.
The ARC will be created by state banks and the private sector and there will be no capital contribution from the government. You will have an Asset Management Company (AMC) to manage and sell bad debt.
For banks it will be a kind of cash-neutral exercise, because for the capital that they will contribute to the ARC, they will recover part in cash and the rest as guarantee receipts against the transfer of the stressed assets, a source said.
“For security receipts, the regulator requires some kind of provisioning, for which the banks are asking the government to provide the guarantee required by the RBI (Reserve Bank of India). For 85 percent of the SR portion, banks need a provisioning of about 15 percent. Banks are looking for a sovereign guarantee for that, which we will provide as we move forward. We are going to give sovereign support to support the banks, ”said the official.
If the government guarantees the security receipts issued by the ARC, banks can transfer stress assets to the proposed entity without having to make additional provisions. The 2016 RBI guidelines require banks to make provisions for assets assigned to ARCs.
Of the existing ARCs, only 3-4 are adequately capitalized, while more than a dozen are undercapitalized, necessitating the need to establish a new structure to resolve stressed assets urgently. The transfer of stressed assets to the ARC will occur at the net book value, which is the value of the assets less the provisions made by banks against these assets. This structure will reduce the burden of stressed assets on the bank balance sheet and seek to resolve bad debt in a market-driven manner.
Since most banks are expected to be on board this venture, the resolution is expected to be faster. Since most commercial loans are made by a group of 8-10 banks, depending on the existing resolution mechanism, some banks would normally oppose resolution due to differences, slowing down the resolution process. The proposed structure is expected to solve this.
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