In today's Finshots we talk about why there's so much riding on the government's latest project, the National Asset Reconstruction Company

Policy

The Story

Everybody knows we have a massive problem at hand.

We saw the growth numbers last week — a GDP contraction of 7.3%. It was unimaginable only a couple of years ago and yet, here we are. And while you could attribute a large part of this capitulation to Covid induced lockdowns, it’s safe to say that we still have a herculean task in front of us.

And we can’t do it without the full backing of the banking industry.

See, we often think of debt as an evil enterprise. Borrowing money isn’t what respectable people do, we’re told. But the truth is — Credit powers the economic engine. You can buy a new home because a bank is willing to lend you money. You can set up a new factory because a bank offers you capital to realize your vision. You can aspire to dream big because a bank is willing to fund your venture. And as you keep growing each day, the country keeps growing alongside you. Bottom line — Banks are the at the forefront of weaving the growth story of India. Unfortunately, Covid will push them to the brink soon enough.

Businesses will go bankrupt and they’ll stop repaying loans. And banks will be left with a whole host of bad loans — debt that will likely never be repaid in full. This problem is only exacerbated by the fact that we are yet to resolve the first wave of bad loans that precipitated in the early half of the last decade. Now bear in mind, banks did try to recover some of the money. But how do you make progress when promoters are uncooperative and the only collateral backing the loan happens to be power stations and stalled real estate projects. It’s hard to get them to repay when they’re constantly evading you. It’s even harder to sell the collateral. In fact, you need a whole different kind of expertise to resolve these bad loans.

You might need to take control of some of these companies — rejig their financial structure or maybe fundamentally alter the business model to make sure they’re worth something. It requires professionals — the likes of which you probably haven’t seen before. And even if you wanted to pursue it with diligence yourself, it isn’t easy to do this when you’re a massive bank dealing with a bunch of other things. And it’s imperative the problem is dealt with before a new wave of bad loans make their way as Covid subsides.

So during the budget, the government said it would set up a bad bank called the National Asset Reconstruction Company (NARC). The idea was to take all the problem loans from banks and then pool them under a single umbrella whose sole focus will center on recovering unpaid dues. And if you’re wondering how this entity may work, here’s a simple explainer.

First, they’ll go to all the banks hosting the problem loans and buy it off of them. We could also see an auction where the loans may be sold off to the highest bidder, in which case, NARC will be competing with other similar entities. We will have to wait and see how things pan out.

But remember each bank will have provisioned for these bad loans already. Think of it as a tacit admission where the bank confesses they may only recover 25% of the dues. They’ll already have treated the remaining dues as a loss and so for all practical purposes, the true value of the loan will be the 25% they believe is still recoverable. This will probably be the kind of money NARC will be willing to pay for the bad loans. But they won’t pay for it in cash upfront. They’ll likely pay 20% in cash and promise to settle the rest when they actually recover the money. The numbers are for illustrative purposes only, but you get the idea right?

So yeah, while the banks won’t receive a sizeable injection in cash, they will still get some money upfront. And they can get rid of all the excess that’s been hurting them for so long. Maybe they can focus on new lending once and for all. But this will only be possible if the government is willing to fund the NARC substantially over the short and medium-term. If this entity runs out of cash (or isn’t able to recover those dues within the next few months), then it won’t be able to fulfill its mandate.

Bottom line — There’s a lot riding on this NARC thing. And while the details are still hazy, the hope is that this new entity will finally be able to make a dent in alleviating the bad loan epidemic plaguing India.

Until then…

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