In order to augment the effectiveness of these bad banks, the Confederation of Indian Industry (CII) recommended the government to consider enabling foreign portfolio investors (FPIs) and alternative investment funds (AIFs) to purchase NPAs, in its recently submitted pre-budget memorandum.
“In the aftermath of Covid it is important to find a resolution mechanism through a market determined price discovery. With huge liquidity both globally and domestically, multiple bad banks can address this issue in a transparent manner and get the credit cycle back in action,” said Uday Kotak, CII president.
The suggestions are in line with a Reserve Bank of India (RBI) consultative paper which had proposed that regulated entities may be permitted to purchase NPAs, the CII said in a statement on Monday.
A bad bank is an entity that is set up, often with a government guarantee, to purchase NPAs from banks at market price. This clears the balance sheet of lenders to improve their fundraising capabilities, which in turn increases their ability to provide credit to businesses and individuals.
Selling their NPAs to a bad bank implies that lenders would have to take a haircut on these loans, which brings in a certain amount of risk into the process.
While depositors are protected from losses under this model, shareholders and bondholders stand to lose money, which in the case of PSBs would be the government, implying the loss is ultimately borne by taxpayers.
A robust market-based mechanism would encourage PSBs to sell their bad loans without fear of questions being raised later, the CII said. PSBs would then be able to raise capital from the market, obviating the need for recapitalisation by the government, it added.
Apart from enabling participation of Securities and Exchange Board of India-regulated AIFs, the CII recommended that regulations safeguarding the interests of all stakeholders be framed by the market regulator.
Further, taxation of gains made from recoveries should be made investor friendly to attract global investors into such AIFs and to ensure price maximisation for the selling banks.
Currently, NPAs are largely sold to asset reconstruction companies (ARCs) on a security receipts-basis rather than cash, wherein payments are made only upon recovery. RBI data and industry estimates show the recovery rate to be a low 10-12%.
While Parliament, in September, approved Rs 20,000 crore of capital infusion into PSBs, the latest Financial Stability Report from the RBI has pegged gross NPAs of commercial banks to jump from 8.5% last March to 12.5% by March 2021.
Banks need to gear up to lend more as credit demand from industry expands along with economic recovery, the CII said.