Bad Banks in India | Contents

Bad Banks in India November 2020

Contents

India – Banking sector Non-Performing Assets 3 Impact of COVID-19 on Banking sector NPA 5 Bad banks – An overview 6 Bad banks – Prior experience and evolution 7 Pros and Cons of establishing a Bad bank 8 Bad bank – Alternatives 10 Bad bank – Global experience 12 Conclusion 14 Appendix 15

Bad Banks in India || ContentsContents

Bad Banks in India | India – Banking sector Non-Performing Assets (NPA)

India – Banking sector Non-Performing Assets (NPA)

The issue of Non-Performing Assets (NPAs) in the Indian banking sector has long been a subject of much discussion and scrutiny, impacting (PSU) banks’ capacity to lend in the past

Introduction Over the 11-year period since, the GNPA A sound banking system is a prerequisite for SCBs increased to INR 9,36,474 The stress in PSU banks for developing a sound financial and crores at 31 March 2019, implying a has increased economic system. However, the issue of CAGR of 33.06 per cent, far outstripping non-performing assets is a huge hurdle the growth of banking sector credit significantly over the in the smooth functioning of the banking growth during the same period. system. A high level of NPAs indicates a years high probability of credit default thereby An analysis by Centre for Financial reducing the overall efficiency and Accountability indicates this: “The table below highlights that effectiveness of the lending system. It stress in PSU Banks has increased also significantly reduces the availability Between FY15 and FY19, if opening significantly from 5.0 per cent of of credit, thus creating a problem not NPAs were based at 100, on an average, gross advances at Mar-15 to 11.3 per only for the banks but also for policy real slippages were being added at 67 cent of Gross advances at Mar-20. makers, affecting the economic growth per cent, recoveries with upgradation at of the country. 20 per cent, while write-off contributed Similarly, GNPA for all SCBs has above the recoveries at 22 per cent. This increased from 4.3 per cent to 8.5 Banking NPA – Status (Pre COVID-19) has resulted in cumulative NPAs per cent during this period. In the last few years, banks have been increasing at 25 per cent (100+67-20- under the scanner because of increasing 22=125) in the past five years. NPAs. The Gross NPA (GNPA) of all Scheduled Commercial banks (SCBs) in India in 2007-08 was INR 40,452 crores.

Bad Banks in India | India – Banking sector Non-Performing Assets (NPA)

Table: Trend in Indian Banking NPA

Country FY15 FY16 FY17 FY18 FY19 FY20

Public sector Banks 5.0% 9.3% 11.7% 14.6% 11.6% 11.3%

Private Sector Banks 2.1% 2.9% 4.1% 4.7% 5.3% 4.2% Foreign Banks 3.2% 4.2% 4.0% 3.8% 3.0% 2.3%

Small Finance banks 0.0% 0.0% 1.2% 2.5% 2.0% NA

GNPA (%) – All SCBs 4.3% 7.5% 9.3% 11.2% 9.1% 8.5%

GNPA – SCBs (INR TN) 3.2 6.1 7.9 10.4 9.4 NA Gross Advances - SCBs 75.6 81.7 85.0 92.7 102.3 NA Source: RBI Financial Stability Reports Global context As per World Bank data, share of NPA to gross loans in Indian banking is “As per available numbers (some of which significantly higher compared to are provisional) at this point of time, the developed western economies and also overall capital adequacy ratio for scheduled commercial banks (SCBs) stood at 14.8 per exceeds most other emerging cent as in March 2020, compared to 14.3 per economies, with an exception of the cent in March 2019. The CRAR of PSBs had Russian Federation. improved from 12.2 per cent in March 2019 to 13.0 per cent in March 2020. Large unresolved NPAs over a sustained period of time have proven detrimental The gross NPA ratio and net NPA ratio of to policy making and economic growth SCBs stood at 8.3 per cent and 2.9 per cent in for many economies in the past. March 2020, compared to 9.1 per cent and 3.7 per cent as on March 2019, respectively. The Provision Coverage Ratio (PCR) improved NPA (%) on Gross loans from 60.5 per cent in March 2019 to 65.4 per 15.0 cent in March 2020, indicating higher 9.4 10.1 9.2 9.5 resiliency in terms of risk absorption 10.0 capacity.” 5.0 2.9 3.7 Shri Shaktikanta Das (RBI Governor) 1.3 0.9 0.9 1.1 1.7 1.2 1.7 1.8 at a recent address at Seventh Banking & 0.0 Economics Conclave on 11 July 2020 USA UK Germany South China Russia India

NPA (%) on Gross loans - 2016 NPA (%) on Gross loans - 2018

Background to rising NPA As per an ex-RBI Deputy Governor, the stressed assets have been an outcome of excessive bank lending, in a relatively short period from 2009 to 2012, and to a concentrated set of large firms in a number of sectors such as infrastructure, power, telecom, metals (iron and steel, in particular), engineering-procurement-construction (EPC), and textiles.

Bad Banks in India | Impact of COVID-19 on Banking sector NPA

Impact of COVID-19 on Banking sector NPA

As per RBI’s 21st Financial Stability Report (July 2020), macro stress tests for credit risk indicate that the GNPA ratio of all SCBs may increase from 8.5 per cent in March 2020 to 12.5 per cent by March 2021 under the baseline scenario. If the macroeconomic environment worsens further, the ratio may escalate to 14.7 per cent under very severe stress.

Additional NPA stress scenario. This, however, does not take into account the proposed The policy imperative mergers or any further The impact of the Covid-19 pandemic recapitalization. Industry participants and policy and the ensuing lockdowns is expected makers are evaluating multiple • In the wake of Covid-19, the RBI had to add another layer of stress on the options on the way to control the announced a six months loan already stretched Indian banking impending NPA wave. There is added moratorium for all term loans. The system. As per a recent note by rating urgency because the government same was applicable from 1 March agency India Ratings and Research (Ind- has put on hold any fresh reference 2020 to 31 August 2020. RA): to the NCLT under the Insolvency • As per RBI data, about 80 per cent and Bankruptcy Code, 2016 (IBC) for “In a scenario wherein funding markets of retail borrowers who had taken one year. continue to exhibit heightened risk loans from public sector banks had aversion, corporate stress could increase availed of the moratorium. For Further, according to a report by further by INR 1.68 lakh crore, resulting NBFCs and small banks, that figure Kotak Institutional Equities, banks in INR 5.89 lakh crore of the corporate was 45.9 per cent and 73.2 per cent, have seen an average haircut of 88 debt becoming stressed in FY21-FY22. respectively. per cent in the cases that were Consequently, 20.8 per cent of the resolved in the October-December • The Covid-19 lockdown had a outstanding debt could be under stress 2019 period, which was the highest significant impact on all industrial in the agency’s stress case scenario.” percentage of haircut that lenders activities in the economy resulting have had to take in a single quarter in major income loss. This has RBI’s assessment of COVID-19 impact since the introduction of the IBC in impacted their loan repayment 2016. The report states: “Barring a ability. few cases, almost all resolutions in • The RBI has warned that the GNPA • This may lead to Gross Domestic Q3 FY20 had a haircut of more than ratio of all SCBs may increase from Product (GDP) contraction by 8.9 60 per cent.” 8.5 per cent in March 2020 to 12.5 per cent in 2020-21 per cent by March 2021 • The RBI projected that Capital • The GNPA ratio may also worsen to Adequacy Ratio (CAR) ratio could as high as 14.7 per cent by the end slide to 13.3 per cent in March 2021 of the current financial year, if the under the normal scenario and to adverse economic impact of the 11.8 per cent under the very severe Covid-19 pandemic would be ‘very stress scenario. severe’ • The RBI has stated that the Indian • Stress test results indicate that 5 financial system remained stable, banks may fail to meet the despite the significant downside minimum capital level by March risks to economic prospects in short 2021 in a very severe stress term

Bad Banks in India | Bad banks – An overview

Bad banks – An overview

With banking sector GNPAs in India perhaps already above INR 10 lakh crore, and expected to increase to upwards of INR 15 lakh crore in the near future, there is an increasing ask to unburden the banking system of NPAs and expedite the recovery process.

Overview called ‘Sashakt’ for resolving large bad – The fiscal implications would be One of the key ideas being deliberated is loans. similar to public sector bank re- the formation of a Bad bank/s to help capitalization. Over the years, de-stress banking balance sheets. Illustrative Bad bank structure the Government has been An illustrative Bad bank structure could recapitalizing PSU banks and A Bad bank is a corporate structure that potentially work as outlined below. The has already infused over INR isolates risky assets held by banks in a illustration draws from Malaysia’s 3.5 lakh crore in last five years. separate entity. It is established to buy experience with their institutions As per ICRA estimates, the toxic assets from a good bank at a price ‘Danaharta’ and ‘Danamodal’ after the capital requirements for PSU that is determined by the Bad bank, Asian crisis. banks would be in the range of most likely with a haircut to the book INR 20,000-55,500 crore in value of the stressed loans being • The government could set up a bad 2020-21 as against government transferred. It may be controlled by the bank (‘Bank X’) with an agreed upon planned budget of INR 25,000 government, and apart from the capital base. The equity infusion crore for re-capitalization. government, other private players invest could be funded via Government of • If Bank X recovers more than the in its equity. It may raise loans from India re-capitalization bonds issued consideration paid on acquired NPA other participants. These transactions to subscribers loans, it may be required to share a happen at arm's length and a Bad bank • Bank X could acquire tranches of certain portion of such excess with is managed by professionals with bad loans from across Banks/ the transferring banks. Any recovery domain knowledge of managing stressed NBFCs. Assuming average fair value below such fair value would be the assets. of 40 per cent of book value of sole liability of Bank X. This loans transferred, Bank X could approach could help address the The Indian Banks’ Association (IBA) acquire up to 2.5x worth of gross concerns around asset valuation for recently submitted a proposal to the NPA from troubled lenders both the transferring lender/s and Finance ministry and the Reserve Bank for Bank X and help build of India (RBI) to set up a ‘Bad bank’ to • By transferring such assets to the transparency and trust in the take charge of c. INR 75,000 crore worth Bad bank, the original institution process. of non-performing assets (NPAs) and could clear its balance sheet, had requested the government to although it would still be forced to Such Bank X is to be headed by provide INR 10,000 crore of initial take write-downs specialized distressed asset capital. As per media reports, IBA had professionals with proven integrity and • To protect the interests of taxpayers proposed to set up an Asset experience. Also, the bank could have a and to restore trust, this transfer Reconstruction Company (ARC), an Asset finite lifespan to address NPAs. would have to be done at fair Management Company (AMC) and an market valuations i.e. at a discount Alternate Investment Fund (AIF). The to book value, as certified by ARC will be owned by the government, Government appointed but the AMC and AIF will have independent valuers participation from the public sector as well as the private sector, as per the – Steep haircuts in certain cases proposal. might lead to capital adequacy challenges in a few PSU and The proposed structure of a Bad bank is private Banks, necessitating based on the earlier recommendations recapitalization on a need-basis of a panel headed by former PNB for these banks chairman Sunil Mehta in July 2018, that had proposed formation of an AMC

Bad Banks in India | Bad banks – Prior experience and evolution

Bad banks – Prior experience and evolution

While India has never had a Bad bank in the past, the concept is not new. The idea of setting up a Bad bank was first proposed in an Economic Survey conducted in January 2016. There were discussions on creating a Bad bank in 2018 as well, but it did not materialize

The core purpose of the Bad bank would be to buy bad loans from banks at a discount, in order to attempt recover of money from various defaulters. The Bank would need to be a centralized agency in a position to take tough decisions. This section attempts to describe various points of view as to whether there is an actual need to set up a Bad bank in India and if yes, the design of such an institution. Case study: Industrial Reconstruction purpose vehicle (SPV) trust for May 2019 after examining Bank of India (IIBI) acquiring NPAs of erstwhile IDBI. cases above INR 50 crore that were sold to ARCs between • 636 stressed/non-performing cases 2013-14 and 2017-18 by PSBs. with aggregate loans of over INR • The Industrial Reconstruction – The report mentions that, in at 9,000 crore were hived off to the Company of India was set up in least 48 cases, assets were sold SPV 1971, with the purpose of to ARCs below the realizable rehabilitation of sick units • However, it could only recover less value of security than half at INR 4,000 crore at the • Low recovery: Recovery of security • It was re-modelled as IIBI or end of March 2013, according to a receipts via ARCs sold by PSBs Industrial Investment Bank of India 2014 audit report by the between 2013-14 and 2017-18 has in 1985 and was assigned the role of Comptroller and Auditor General of been subdued buying bad loans from commercial India (CAG) banks to recover these debts

• However, IIBI became sick eventually due to lack of strict Case study: ARC model in India recovery laws. The Government had to infuse approximately INR 263 crores as grants to IIBI from 2004- • In India, private asset 2005 and from 2005-2006 for reconstruction companies (ARCs) servicing its debts have been buying NPAs from various banks (29 registered ARCs • There was also a proposal to merge operate in India currently), but the IIBI and other institutions such as model has not yielded desired IFCI and IDBI, but the proposals results. were rejected; IBBI eventually closed down in 2012 • ARCs act merely as recovery agents because they lack the bandwidth to Case study: IDBI Stressed Asset reconstruct any company under Stabilization Fund stress which is sold as a going • In 2004, IDBI (Industrial concern. Development Bank of India) was provided with a bailout package to • The efficacy of the ARC model is shift its bad loans to a Stressed under question: Asset Stabilization Fund (SASF) – The Central Vigilance • The SASF was constituted by the Commission (CVC) submitted a Government of India as a special report to the government in

Bad Banks in India | Pros and Cons of establishing a Bad bank

Pros and Cons of establishing a Bad bank

While India could deliberate on the case for establishing a Bad bank, it is critical to evaluate the pros and cons for the same.

In-house management Vs ‘Bad Bank’ setup: Key considerations When managing non-core assets, banks must decide between in-house management and a structured solution such as a ‘bad bank’. Whilst complex to set up, a structured solution gives a strong message to the market, optimizes the transfer of risk, facilitates straightforward portfolio sales and therefore makes rapid deleveraging simple, all whilst insulating the ‘good bank’, enabling it to recover from the crisis, and thrive.

Facilitation of Ease of Portfolio Model Operations Risk transfer Market External Investments Sales in Bad Bank Confidence in Bad Banks

Segregated Portfolios Limited Risk Transfer Challenging Upon Setup (mixed value Simplest Least Transparent Least Straightforward  Management (Subsequent portfolio attribution, impacts reporting only sales will transfer risk) “good bank”)

Virtual Non-Core

house house

- In

Management  Creation of Straightforward internal division  External reporting

SPV or classic ‘Bad Bank’ Most Straightforward Minimum Risk (simple attribution, Most complex Greatest Transparency Straightforward Transfer Upon Setup insulation of “good  Separate legal

Legal Legal bank”) entity Separation

Key arguments in favor of establishing a • Reduce the balance sheet and debts. International experience Bad bank: realise value from non-core shows that a professionally run Bad banks are more complex and time assets through tailored central agency with government consuming to set up but have benefits solutions backing could overcome the both in terms of the core franchise and coordination and political issues • Release capital into or lower in terms of the non-core assets which that have impeded progress over the capital requirements at the are being worked out. the past years. core business • Domain expertise: • Frees management bandwidth and • Quicker resolution: Pooling of bad • A dedicated Bad bank may be specifically allows the management assets under a single entity can help better than a number of PSU to: in terms of resolutions (quicker banks replicating similar • Focus on driving the decisions) as and when growth departments in their respective performance of the core improves and demand for these organizations business assets increase. • Under a competent • Plugs in loopholes in ARC model: • Right-size the infrastructure for management and Board, the the organization Private-run ARCs have not seen much success in resolving bad

Bad Banks in India | Pros and Cons of establishing a Bad bank

value of these stressed assets of the assets under estate, IT and portfolio could be better preserved consideration is estimated to sales/M&A be low. • Domain focus could potentially • The need to utilize help tap long-term pools of • Transfer at computed fair value restructuring techniques for foreign and domestic capital via with steep haircuts may cause a non-core assets when the equity/debt issuance versus severe blow to bottom line of workout unit itself has an the transferring bank, intensive workload • Price Discovery: A Bad bank may be preventing a full transfer of risk better suited to fix the appropriate • The need for management to to the Bad bank as price. The transferring bank could focus primarily on developing contemplated make additional provisions in case the core franchise (good bank) the discovered cost is less than the • Lack of buyer demand: The price at whilst appropriately managing book value and the Bank wants to which toxic assets are to be the non-core assets retain the asset on its books. transferred may not be market- • Ownership disputes: Various determined and price discovery may options could be explored for the Capital relief: Based on the existing not happen ownership of Bad banks - entirely prudential norms as defined by the RBI, • A key challenge includes the need government-backed funding, NPAs are still accounted for in the for rapid, reliable data collection private funding, or a public-private branch books, whereas the and analysis: partnership (PPP). While global Bad corresponding advances are also • Development of a detailed bank models with favorable adjusted for provisions and write-offs to recovery/deleveraging plan arrive the Net Advances figure as outcomes were largely Government published in the audited books of • Design of a structure that owned, many see advantage in accounts. meets capital objectives having a Bad bank owned by the banks collectively. This would • Project based set up with cost Key arguments against establishing a ensure that when a bad loan is base carefully aligned with Bad bank: resolved, the profits would accrue asset recovery/deleveraging • Potential steep haircuts: to the owners, i.e. the banks activity • A prominent issue with Bad themselves. This would make the banks is not the need for it, but • Developing and managing loss they booked on selling the non- how to set it up, particularly appropriate resources in areas performing assets at a discount, when debt and equity capital is such as restructuring and more palatable. scarce and costly and fair value recovery, commercial real

Bad Banks in India | Bad bank – Alternatives

Bad bank – Alternatives

Many experts argue that the enactment of IBC regulations has reduced the need for having a Bad bank, as a transparent and open process is available for all lenders to attempt insolvency resolution.

A former RBI Dy. Governor had proposed two alternative models for a Bad bank in 2017:

Private Asset Management Company plans. Each resolution plan would authorities. Sustainable debt would (AMC) lay out sustainable debt and debt- be upgraded to standard status for • This plan would be suitable for for-equity conversions for banks all involved banks. The promoters, sectors where the stress is such that and cash flow prospects to facilitate however, would have no choice as assets are likely to have economic the issuance of new equity and to what restructuring plan is value in the short run, with possibly some new debt to fund the accepted. moderate levels of debt forgiveness investment needs. Each resolution • At expiry of the proposed timeline, plan would then get vetted and the • In terms of timeline, the banking each exposure that is not resolved asset rated by at least two credit sector could be asked to resolve and would be subject to a steep sector- rating agencies. The rating would restructure, say its 50 largest based haircut for the bank assess the financial and economic stressed exposures in these sectors consortium, possibly close to 100 health and management quality. within a limited time frame of say, 6 per cent. The promoter would have Feasible plans would be selected months. The rest could follow a to leave and these assets would be such that they improve ratings a similar plan in six months moved to the IBC. minimum of two credit ratings thereafter. above threshold default level. • Such asset management company • For each asset, turnaround would be entirely private, similar to • Banks could then choose among the specialists and private investors, the “Phoenix” structure set up in feasible plans. Haircuts taken by other than affiliates of banks Spain after 2012 to deal with bank banks under a feasible plan would exposed to the asset, may be called NPAs in Machinery, Steel and be required by government ruling as upon to propose several resolution Winery segments. being acceptable by the vigilance

National Asset Management Company (NAMC) • The second model is an NAMC for sectors where the problem is not just of excess capacity, but possibly also of economically unviable assets in the short- to medium-term, such as in the power sector. • The NAMC would raise debt for its financing needs, keep a minority equity stake for the government, and bring in asset managers such as ARCs and private equity to manage and turn around the assets. Figure: NAMC structure examples

Centralised, Multi-bank, Bad Bank Schemes Government Guarantee Schemes

Good Investments Third Party Shareholders Bank Good Premiums Investors

Bank Government

Guarantees Bad (guarantor ) SPV NPLs Bank Government

SPV NPLs Loss Protection

(Equity/ Debt) Cash Distributions purchase Government subject to Threshold Distributions Note: Government can act as similar guarantor for an SPV Examples: Sareb (Spanish Bad Bank), NAMA (Irish Bad Examples: Citi (US), Bank of America (US) Bank), UBS (Switzerland), Securum / Retriva (Swedish Bad Bank), RTC (US Bad Bank)

Bad Banks in India | Bad bank – Alternatives

Advantages of the National AMC Key considerations - Assets Key considerations - Infrastructure structure - • There may be a large number of • Servicing could initially take place NAMCs are more complex and time originating banks, which would across a large number of originating consuming to set up but provide many make the set-up of a National Asset banks. It would be necessary to advantages if a sector-wide solution is Management Company more amalgamate this and form a view on required: complex best practices. It would also be critical to set strong SLAs to ensure • Single institution delivering greater • Visibility over the current/end that reporting, KPIs, rights, transparency for investors, portfolio may be difficult, and it obligations and incentives are regulators and other stakeholders would be necessary to devise a clearly communicated common reporting template • Facilitates a sector wide strategy • In the medium term, the servicing and oversight • COVID-19 has affected SMEs across could go out for tender in order to the industry spectrum, making • Ability to enforce common simplify and maintain tighter management more complex than a standards and approach control single asset class, but furthermore, • For regulators/ supervisors, a single SME data is likely to be very poor • High volumes would require entity to focus on rather than many standard viability testing and • Governments should look not only structures based on sustainable • Single funding structure and to take bad loans from banks, but debt levels and EBITDA. It may be approach carve out entire debtors which have necessary to define debt borrowing from multiple banks, or • Allows common approach to sustainability at the industry level the government, or have common borrowers regardless of government guarantees • Technology would play a key role; origination The system could either allow • Need to consider the structure and • Centralized pool of underlying real servicers to run with their own funding of new money requests estate collateral provides technology (with common (debt/equity/working capital) opportunity for central control and reporting) or design a common strategy for longer term benefit of servicing platform for all players to the real estate market use

• Control moves away from existing

management

Bad Banks in India | Bad bank - Global experience

Bad bank - Global experience

In the past, multiple mechanisms and measures have been adopted by other jurisdictions to tackle increasing non-performing loans. Of these, the following countries are relevant to study from an Indian context.

Country Malaysia Ireland Thailand Korea Indonesia China

AMC regime Public Public Public & private Public & private Public Public (mixed public & private ownership)

National AMC Danaharta NAMA SAM BAM KAMCO IBRA Cinda (listed) name (listed 2019) Huarong (listed) China Orient, Great Wall, Galaxy, Provincial AMCs

No. of National 1 1 2 1 1 4+1+N AMCs

First established 1998 2009 2001 1997 1998 1999

Current Status Inactive Live Live Live Inactive Live

Main asset type Corporate CRE Mixed SME Corporate, Corporate Corporate/SME & Retail public and households

Key law/ Danaharta Act NAMA Act AMC Decree KAMCO Act Banking Law Government regulation (law no. 10 of banking reform 1998)

Key characteristics Transfer of NPLs Large strategic Mix of public Acquires and Transfer of NPLs Country level from target real estate and private resolves from target effort to reduce banks with a focused. sector solutions financial banks with a NPLs from all finite life AMC. NAMA acquired at national, bank institution’s finite life AMC. banks. Since Dealt with 12,000 loans at and investor NPLs and In 2002, IBRA there was an nearly 3,000 a cost of €31.8 level. corporate failed to influx of bad NPL accounts billion from five A key restructurings. accomplish its assets with and its lifetime banks. NAMA differentiator KAMCO mandate and negligible loan recovery adopted a between TAMC purchased shifted its demand, rate of 58 per consensual and other AMCs, 30,000 odd NPLs strategy to rapid realized sale cent surpassed approach with is that the with a face value asset value was low, the typical 20‐50 the debtors former does not of US$ 92 billion disposition. resulting in per cent range towards have the power (won 110 trillion Over the period, losses at the for similar resolution to sell loans to - 20 per cent of IBRA sold 60 per AMC level agencies in Asia. third parties. the GDP). The cent of its NPL (AMCs However, it can discount portfolio and depended on

Bad Banks in India | Bad bank - Global experience

sell foreclosed the type of loan, the average achieved an real estate to with the highest recovery rate overall recovery third parties. prices paid for was 22 per cent, rate of 33.6 per ordinary loans with 44 bank cent, with cash (67 per cent), owners deemed recovery at 22.4 lowest price was to violate the per cent. paid for regulations of unsecured Bank Indonesia. ordinary loans (11 per cent) and the other loans ranged between 20-50 per cent.

Key learnings from global experience structure could lead to losses for Based on global experience, key the AMCs. learnings for a prospective Indian Bad bank entity are as follows:

1. A common key success factor is substantial upfront government funding, with less reliance on other banks, borrowings or AMC bonds for capital. If the AMC/s are funded mainly through debt, they run the risk of accrued interest on bonds and loans exceeding the cash recovery from the resolution of NPAs. 2. The Bad bank entity/ AMC could broaden its shareholder base by inviting participation from domestic and foreign institutional investors. 3. The Bad bank could be established with a finite lifespan to ensure better resolution and to reduce logjams 4. The bad bank could include professionals outside government staff, with secondment from the private sector, including reputable banks, investment banks and international and sectoral experts 5. The NPAs should be transferred to AMCs at fair value considering a probable haircut and not at book value. If NPAs are transferred at book value, all losses would need to be taken at the AMC level. In a scenario of negligible demand and low realized sale value, this

Bad Banks in India | Conclusion

Conclusion

While there's no official communication Banks' Association. The government's prudential write-off & IBC haircut from the RBI about the creation of a view is that bad loan resolution should provisions made during the last four 'bad bank' or a one-time loan happen in a market-led way.” years have further accentuated the restructuring proposal so far, a loan problem. In most cases, it is the PSU NPAs in India have reached an alarming recast scheme for certain categories of Banks that are the worst hit because of level, given short term and long term borrowers has been announced. such provisions. Smaller banks have also issues, combined with the stringent suffered given their presence as smaller As per a Government official, "We have provisioning policies and guidelines of consortium participants as well as lower studied the banks' proposal (bad loan). the Regulators and the ruling diversification in loans. The fact is there are already market-led Governments. Lack of appropriate credit options available for asset risk processes, lack of transparency in To pivot towards sustainable lending reconstruction and it looks better that the operations and lack of democratic going forward, the Government would way," atmosphere in the banking industry and need to act fast on resolving the NPA certain indiscriminate lending has added issue, bring in accountability with “The government is not keen to infuse to the pile of NPAs. Major write-off lenders and reforms to guard against a equity capital into a bad bank, which has provisions including unhealthy repeat of the bad loan cycle. been recently proposed by the Indian

Bad Banks in India | Conclusion

APPENDIX

Bad Banks in India | Conclusion

BAD BANK – GLOBAL EXPERIENCE In 1980s, the US based Mellon bank proposed the idea of ‘Bad Bank’ as a strategy to manage bad loans. The Grant Street National Bank (1988), held USD 1.4 billion of bad loans, that was later dissolved in 1995. Globally, ECB is working on a draft to manage bad debt piling due to Covid stress.

A. Malaysia – Danaharta-Danamodal central bank (BNM) realized the Debt Restructuring In 1998, Asian crisis severely need for large scale resolution and Committee (CDRC). impacted the Malaysian Banking jointly announced various • BNM provided incentives such system, the NPL ratio spiked from measures: as recapitalization to banks 3.6 per cent at June 1997 to 13.2 who achieved sell off NPLs to per cent by the end of 1998. • Setting up of an AMC (Danaharta) for acquiring Danaharta. Although, short-term measures NPLs and restructuring them • Consolidation through such as pegging exchange rate to maximize recovery, a mergers system to USD, capital controls and banking recapitalization a fiscal stimulus package provided agency once NPLs are sold some relief, the government and (Danamodal) and a Corporate

Figure: Revival strategy implemented

Malaysia bad bank experience - • Danaharta dealt with nearly 3,000 • The CDRC resolved 47 cases with outcome NPL accounts and its lifetime loan total debt amounting to RM 43.9 recovery rate of 58 per cent billion, with 83 per cent of recovery With the above cohesive efforts, the surpassed the typical 20‐50 per cent proceeds in cash, redeemable government and BNM were able to range for similar agencies in Asia. instruments and re-scheduled curtain NPLs (down from 13.2 per cent debts. in CY1998 to 7.6 per cent in CY04) and • Danamodal infused over RM 7 achieve consolidation by bringing down billion in CY99 and CY2000. As of With the banking system coming back the number of commercial banks to 10 November 2003, all banks, except on track, stock prices of large Malaysian from 50. RHB Bank Berhad, repaid their loans banks shot up during that period. and it was closed by end‐2003.

Bad Banks in India | Conclusion

B. Ireland - NAMA purposes, obtain the best of €42.6 billion (or 57 per cent of Background: In late 2008, post the achievable financial return for the amount owned by borrowers). collapse of construction and the state In the end, NAMA acquired 90 per property markets and crash in cent of the identified eligible loans NAMA established special-purpose bank share prices, the Irish and the value was removed from vehicle (SPV), to avoid government announced a blanket the books of banks. It issued consolidation of the Irish public guarantee of all Irish bank government-guaranteed bonds of accounts. The National liabilities amounting to €440 €30.2 billion to banks and Management Agency Investment billion, or twice the annual gross remaining €1.6 billion was paid by Limited (The Master SPV domestic product (GDP). The the issue of subordinate debt on purchases, manages and sells the guarantee was based on the belief NAMA’s financial performance. distressed assets and issues debt that banks needed temporary securities to purchase assets) is liquidity but were intrinsically Performance: NAMA’s owned at 51 per cent by three solvent. Due to the steady performance is measured by cash private companies and 49 per cent downfall of bank share prices and generation from its portfolio, by NAMA. Under the shareholders’ property prices, the government ability to repay its debt and invest agreement between NAMA and injected capital into three largest in its asset and manage debtors private investors, the former Irish banks; Anglo Irish, Allied Irish (82 per cent of the portfolio, rest exercises a veto over decisions Banks and Bank of Ireland are managed by the banks). All the taken by the company. (government injected €3.5 billion debtors had to agree to business plans; to generate both recurring in the latter two banks in return Establishment and early years: By and sales income. for preference shares). the end of 2010, most of the loans acquired from the participating In March 2009, a report on options NAMA adopted a consensual banks had been transferred to for resolving troubled property approach with the debtors, which NAMA. Instead of using Asset loans proposed the creation of meant; 1) the debtors had to agree Quality Review (AQR) to access National Asset Management to schedules of the asset and loan transfer price, NAMA used Agency (NAMA). Few reasons why sales 2) reverse certain asset discounted cash flow of the NAMA was preferred: 1) The transfers 3) grant NAMA charges collateral values and appointed property had not yet reached rock over unencumbered assets and 4) real estate appraisers to value c. bottom 2) The government had to putting rental income from 10,700 properties. In parallel, the exit from blanket guarantee as the investment assets controlled by Central Bank of Ireland Irish sovereign debt was debtors within NAMA’s control. If implemented two rounds of unfavorably priced and there was the debtors failed to comply, forward-looking capital no plan on Irish banks’ capital enforcement actions were taken. requirements assessments in 2010 adequacy problems. 3) Re- and 2011. Together, it resulted in establish credibility in the Irish A key aspect of NAMA’s work has cumulative capital requirements of banking system. been to provide funding on a €79 billion (46 per cent of 2011 commercial basis (to complete Mandate and legal powers: NAMA GDP). existing projects and commence was created by an Act of new projects). A total of €1.6 NAMA adopted a long-term Parliament in November 2009 with billion was approved for residential economic valuation methodology; the following objectives: and commercial developments, an uplift factor to reflect with a raise up to €3 billion for • To acquire impaired assets anticipated proceeds from the residential development and from the credit institutions property sales when market delivery of the Dublin Docklands participating in the NAMA conditions normalized. The Strategic Development Zone; a scheme average uplift factor was 8.5 per fast-track planning area earmarked cent against the projected disposal to provide commercial • Deal expeditiously with the receipts by 5.25 per cent. accommodations for the growing assets foreign direct investments in NAMA acquired 12,000 loans at a • Protect, or otherwise enhance Ireland. cost of €31.8 billion from five their value, in the interests of banks. The face value of the loans the state Challenges: After six years, NAMA and associated financial derivates faces challenges with respect to • Insofar as possible and acquired was €74.4 billion which staffing: Initially NAMA consistent with those led to crystallizing losses in banks

Bad Banks in India | Conclusion

remunerated staff at par to private sector and implemented bonuses but since it falls under the public sector it had to eliminate the latter and cut wages, which resulted in losing critical staff members. Although in recent years, NAMA introduced a retention scheme with redundancy payment if staff remained until the institution was wound up. The other challenge was cleaning up of the banking system: NAMA could not clean up the bad assets of the banking as it extended beyond land and development loans. The non- performing loans (NPLs) in Irish banking system at the end of 2014 accounted to 23 per cent of the total loans. Establishment of a standalone AMC to deal with land development loans and complimentary policies to deal with small NPLs such as a new personal insolvency framework and accelerated write-off policies are necessary as banks could not classify the loans.

Bad Banks in India | Conclusion

C. Thailand - TAMC and/or reorganize the debtor’s representative of the Federation of Background: Prior to 1997, the business operations, an effort to Thai Industries, another from Thai Thai economy grew at an annual return the firm to profitability and Chamber of Commerce and third rate of c.10 per cent that later enable it to repay its debts. from Thai Bankers Association. The resulted in large current account Majority of the sub-quality assets directors, with a term of six years deficit, appreciation of the transferred to TAMC were from has a board policy of setting exchange rate, increase in short- state-owned banks and obligations powers; operational rules, term foreign debt and a weaker of larger borrowers involved in regulations and procedures and financial sector leading to a multi-creditor transactions. are responsible to supervise the financial crisis that depreciated the general affairs of TAMC. baht and downfall of economic A key differentiator between activity, investment, consumption, TAMC and other AMCs, is that the The internal audit committee and export demand. former does not have the power to appointed by the board is sell loans to third parties. outsourced to Pricewaterhouse Total assets in the financial sector However, it can sell foreclosed real Corporation (PwC) and the amounted to THB 8.9 trillion ($212 estate to third parties. TAMC external auditor is performed by billion or 190 per cent of the GDP), allows a period of twelve years the Office of Auditor General. It of which the commercial banks from the date of the law (June 7, also appoints an executive accounted for 64 per cent of the 2013), although there are several committee who has the powers, total. As the economy grew, intermediary dates that may result duties and responsibilities to demand for real estate increased in TAMC to cease its operations manage the sub-quality assets whereby banks lent funds despite earlier than the latest allowed acquired from the financial the supply outpacing the demand. date. institution. With the financial crisis, borrowers with loans defaulted that caused Initial capital of TAMC was one TAMC organizational structure the level of NPLs in commercial billion baht all owned by the includes four asset management banks to raise to 48 per cent by Financial Institution Development departments and one business 1999 from 12 per cent in 1997. Fund (FIDF), a separate legal entity restructuring department. The within the Bank of Thailand (BoT- former is responsible for assessing Several strategies were adopted by established in 1980s); to provide the viability of borrowers and the Thai authorities to reduce the liquidity and solvency support to businesses; to plan, implement and level of NPLs in the banking financial institutions. BoT issued monitor debt restructuring system, one of which was the short-term notes to fund the initial schemes. While the business establishment of Corporate Debt capital of TAMC. To increase restructuring department manages Restructuring Agency that capitalization TAMC issued shares the restructuring plans to support facilitated the restructuring of the to the public or any other person the AMC and business loans by the banks and their approved by the Council of restructuring process. borrowers. Later, a law was passed Ministers, the remaining unsold to encourage banks to establish shares was purchased by FIDF. Rules for assets: their own asset management companies (AMCs) as subsidiaries. In short, TAMC was established not • Asset acquisition: TAMC However, the authorities followed as a liquidation authority, but as a divides the financial the practice of other Asian re-establishment and restructuring institutions into two: 1) more countries and established a agency with a focus on revival and than 50 per cent owned by the government-owned and operated continuation of businesses to government or FIDF include AMC. enable them to repay their debts single and multiple-creditor and strengthen the larger loans that are expected to Establishment of TAMC: The Thai economy. account to 80 per cent of the Asset Management Company total asset transfers and 2) (TAMC) was established by an Organization structure and privately owned institutions Emergence Decree (Law) on June oversight: TAMC board of directors are permitted to transfer 8, 2001 as a state agency. The goal appointed by the Minister of multi-creditor NPLs. was to consolidate the Finance and approved by Council • Asset Transfer: All sub-quality management of sub-quality assets of Ministers comprises of a assets owned by the of the financial institutions and Chairman and 11 other members, government or FIDF owned AMCs; to restructure the debts of which at least one must be a institutions as of December

Bad Banks in India | Conclusion

31, 2000, including assets cent gain should not exceed where the financial institution the difference between the and borrower are involved in a book value and the transfer lawsuit to settle the debt and price of the asset) and above assets, but have not received a this will belong to TAMC. In verdict from court, must case of loss suffered, when the transfer to the TAMC. On the amount recovered from the other hand private financial asset is less than the transfer institution may transfer sub- price, i.e., less than 20 per quality assets to the TAMC on cent of the transfer price will certain conditions, to name a be borne by the transferring few, 1) the asset must be a financial institution, equal to NPL as of December 31, 2000 20 per cent of the transfer and be secured with two or price will be shared equally more creditors and the and further losses will be the debtors must be a juristic sole responsibility of TAMC. person 2) aggregate book • Amount and types of value of the borrower’s debts transferred assets: Assets are to all creditors must be at not transferred to TAMC on an least THB 5 million and 3) the ongoing basis. Through June financial institution and the 30, 2002, 4,631 cases with the debtor cannot enter into a total book value of THB 18 restructuring agreement billion in five tranches was within 30 days of the coming transferred to TAMC at an into effect 4) prior to the average transfer price to book effect of the law, the value of 33 per cent Bankruptcy Court cannot have approved a rehabilitation plan Resolution of transferred assets that includes the NPL in and debtor cases: TAMC can question. resolve and collect transferred • Transfer price of assets: The assets and is limited by the law to transfer price acquired form certain strategies. As of August the government or FIDF 2002, the number of resolved owned financial institutions is cases reached 800 with a total the market value of underlying book value of THB 293 billion of collateral where from private which, 61 per cent were approved financial institution is lesser of for debt/ business restructuring or the market value of the rehabilitation in the Bankruptcy underlying collateral or the court while the rest were resolved book value of the transferred by foreclosure of collaterals, final assets minus statutory receivership of assets, or verdict by reserves required by BoT. the Civil Court. • Gain-loss sharing agreement applied to transferred assets: TAMC and the transferring institution share in the gain and losses generated by the assets under management, but not on equal basis. If a gain is recorded, any amount up to 20 per cent of the transfer price of the asset will be shared equally and the additional gain will to go transferring institution (on aggregation the first 20 per

Bad Banks in India | Conclusion

D. Korea - KAMCO between KDB and other financial of interest. Since the bonds were Background: Until 1999, Korea institutions. guaranteed by the government, experienced a twin currency and they carried zero percent risk banking crisis. Large current KAMCO was focused on the weight for regulatory capital account shortfalls, highly leveraged acquisition, management and purposes, a strong incentive for corporate sector, strong reliance disposition of NPLs. In addition, it banks to sell NPLs and improve on short-term external financial supported the financial institutions their capital base with a minimum and currency mismatch for both through purchase of NPLs; perform 8 per cent capital adequacy ratio. debtors and creditors contributed as a “bad-bank” that engages in to the crisis. Korea’s financial corporate restructuring by Asset acquisition: KAMCO was system, in terms of total assets extending loans, debt-equity authorized to purchase NPLs from represents more than twice of its swaps, payment guarantees and various financial institutions; annual 2001 GDP of which 60 per recover public funds through the commercial banks (bulk purchases cent accounts to the lending efficient management and disposal – 56 per cent of face value), amount from the commercial of assets. merchant banks, investment banks. The estimated peak level of trusts, insurance companies and non-performing assets (NPAs) is The Act required NPL resolution securities firms. NPLs that had said to have exceeded KRW 100 activities to be conducted through multiple creditors and whose trillion (18 per cent of GDP) and Non-Performing Asset removal was considered critical to official and market estimates of Management Fund (The NPA Fund) restructuring of the organizing NPLs as a ratio of loans with a separate legal entity and institution were purchased on outstanding for the commercial different funding sources. priority. banks reached 8 per cent and 15 Organization structure: KAMCO is per cent respectively. KAMCO purchased 30,000 odd governed by 11-member NPLs with a face value of USD 92 To stabilize to economy and Management Supervisory billion (won 110 trillion – 20 per financial system, large-scale Membership which consists of the cent of the GDP). The discount International Monetary Fund (IMF) managing director of KAMCO, depended on the type of loan, with support package of USD 60 billion representatives from the Ministry the highest prices paid for ordinary and government financial of Finance and Economy (MOFE), loans (67 per cent), lowest price resources was injected into the Ministry of Planning and was paid for unsecured ordinary economy. The government relied Budgeting, the FSC, the Korea loans (11 per cent) and the other on Korean Asset Management Deposit Insurance Corporation, the loans ranged between 20-50 per Company (KAMCO). deputy governor of KDB, two cent. representatives from banking Establishment of KAMCO: KAMCO industry and three professional In 1997, to stabilize the financial was established in 1962, as a recommended by the managing sector KAMCO purchased in bulk subsidiary of the state-owned director. Public Fund Oversight to speed up the transfer process Korean Development Bank (KDB) Committee led by the MOFE where the final settlement price for the purpose of liquidating monitors the NPA fund. was close to the loan loss KDB’s performing assets. In 1966, provisioning rates then in effect it purchased NPLs from other Funding: The NPA Fund’s principal and was subject to negotiation of financial institutions and over the source of financing NPL purchased ex-post individual settlement years it developed into a was issued by government- agreements. Post 1998, a central specialized real estate guaranteed bonds. KAMCO raised feature of these arrangements was management company. Fast a total of USD 18 billion (won 21.5 a recourse arrangements or forward to 1997, KAMCO was trillion) through the issuance of put/call option that allowed either reorganized pursuant to the “Act bonds, from assessments on KAMCO to return (put option) or on Efficient Management of Korea financial institutions in proportion the seller to request (call option) Asset Management Corporation” to their holdings of NPLs and a the return of the loans if the initial (KAMCO Act) as a public nonbank loan from KDB. It recycled USD 15 bulk purchase price and the financial corporation, under the billion of recovered funds to eventual resolution price differed. supervision of the Financial support its purchases. Maturity of Although, as the market matured Supervisory Committee (FSC). The the bonds was within one-five and stabilized and with more government owns 42.8 per cent of year, carried fixed and floating information available on price KAMCO and the remaining is split coupons and yielded a market rate transactions, KAMCO abandoned

Bad Banks in India | Conclusion

the put/ call option and the sellers efficient court ordered were free to decide whether to program. accept the price or not. As of December 2002, KAMCO Asset disposition: KAMCO’s overall resolved USD 54 billion of its USD resolution strategy combined 92 billion in assets, at an average disposition and medium-term debt recovery rate of 46.8 per cent of workout and restructuring. face value. KAMCO’s disposition strategy can

be divided into four broad categories depending on the nature and size of the NPL:

• Bulk loan resolution: Bulk sales were attractive as they resolved large number of loans that resulted in substantial cash flows and attracted foreign investments through an international bidding process. KAMCO used asset-bidding securitization (ABS), involved the transfer of NPLs to SPV which then issued securities, payable from the collection of all the NPLs in public market. KAMCO issued a total of 14 ABS transactions for 18 per cent of the face value of loan resolutions while recovering 12 per cent of the face value of the underlying securities and 99 per cent of their purchase price. • Establishment of joint venture(s): KAMCO sold large portfolios to joint ventures and equity partnerships. A joint venture in which KAMCO holds 50 per cent ownership interest were established to manage and dispose real estate or to enhance recovery values through corporate restructuring. • Foreclosure, public auctions and individual loan sales: KAMCO sold assets through courts, by public auctions and to directly to corporates. • Loan workout or restructuring: Restructuring was either conducted through an informal out-of-court framework or under the less

Bad Banks in India | Conclusion

E. Indonesia – IBRA The Banking Law Amendments and to the majority owner. In total Background: Indonesia Implementing Regulations IBRA recovered Rp 19 trillion from experienced the worst economic remained silent regarding sale proceeds and dividends from crisis due to the Asian financial governance and transparency. its equity holdings. crisis in mid-1997. The crash of Changes were introduced by the rupiah exchange rate and rise in World Bank and IMF but were The asset management unit interest rates caused defaulters ineffective. Over time IBRA managed NPLs with a book value from the corporate sector which improved; operating results were of Rp 346.7 trillion (27 per cent of resulted in numerous banks to reported to the legislative, 2000 GDP). IBRA’s NPL portfolio experience liquidity shortage and financial results were audited in accounted to 90 per cent of NPLs insolvency. In 1998, GDP accordance with generally in the system and were segmented contracted by 14 per cent, inflation accepted accounting principles and by loan type with different increased to 45 per cent and published, budget was revised and resolution strategies applied to interest rates soar to 70 per cent. approved on a gross base and each category. The authorities were forced to take IBRA’s goals on recovery were extraordinary measures to provide publicly disclosed and tracked. In 2002, IBRA failed to accomplish liquidity, capital and restructure its mandate and shifted its strategy the banks under the newly created Funding: IBRA was funded by the to rapid asset disposition. The loan Indonesian Bank Restructuring Indonesian budget. The bonds sales were conducted through a Authority (IBRA). were not issued instead transparent, market-based process government directly issued bonds with the floor price determined by Establishment of IBRA: IBRA was to recapitalize the banking sector. an in-house assessment of each created on January 26, 1998 for a Annual recovery targets for IBRA loan’s market value. Over the period of five years as a bank were established whereby the period, IBRA sold 60 per cent of its restructuring agency to administer proceeds were remitted directly to NPL portfolio and the average the deposit guaranty and to the government to reduce the recovery rate was 22 per cent, restructure banks. It was budget deficit. reflecting poor quality of loans and established under the minister of the time spent before the sale. finance; the chairman was Organizational issues: IBRA’s appointed by the president and organizational structure was The shareholder settlements unit other members were appointed by divided into three business lines: pursued former bank owners who the central bank. In addition, it was banking restructuring, asset has misused liquidity support. A agreed that upon dissolution the management and shareholder total of 44 bank owners deemed to remaining assets belonged to the settlements. Each department violate the regulations of Bank state. focused solely on its business Indonesia. The funds could be excluding the other divisions, recovered if the former owner IBRA’s role was expanded to which led to each area maintaining transferred assets of enough value include; (i) managing the NPLs its own internal database and to IBRA. The other option was to from banks that have been closed, operating systems resulting in appoint a representative on the nationalized or jointly recapitalized inconsistency in data. The other board of the corporation, leaving by government and their issue was IBRA recorded the loan the existing members with full shareholders and (ii) negotiate and assets at gross book value rather access to and control over the manage settlement agreements than market value resulting in assets. By 2004, when IBRA with the controlling shareholders overestimation of realizable value. dissolved, it only had recovered of the closed banks. The initial The public confidence dipped 22.4 per cent of the Rp 130.3 mandate lacked guidelines losses were observed in early sales trillion owned by former owners. governing the division of rather than recoveries. supervisory responsibilities Performance and winding up: between Bank Indonesia and IBRA Asset disposition and Bank sales: IBRA was discounted as of which led to confusion within the IBRA closed 54 banks, nationalized February 2004. Although it public, banks and organizations. In 21 banks and held 6 jointly performed well as a bank the end, Bank Indonesia recapitalized banks. Banks were resolution agency, it was reassumed responsibility for mainly returned to private comparatively less successful with supervision and IBRA was the ownership through transparent respect to maximizing recovering agent. auction process with majority through loan restructuring and stakes sold to the market or blocks shareholders settlements. Over

Bad Banks in India | Conclusion

the period of six years, IBRA assets were transferred to a newly recovered Rp 151 trillion or 23 per established AMC under the cent of the Rp 650 trillion cost of Ministry of Finance. the crisis. Remaining Rp 275 trillion

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