Public sector lenders led by Canara Bank have officially formed the National Asset Reconstruction Company Limited (NARCL), or the Bad Bank. NARCL has been registered in Mumbai with a paid-up capital of Rs 74.6 crore, as per filings with the Registrar of Companies (RoC).

The bad bank will be headed by Padmakumar Madhavan Nair, a stressed assets expert at State Bank of India (SBI), as managing director. The other directors are Indian Banks’ Association (IBA) Chief Executive Sunil Mehta, SBI Deputy Managing Director Salee Sukumaran Nair and Canara Bank representative Ajit Krishnan Nair.

What is a Bad Bank?

A bad bank is a bank set up to buy bad loans and other illiquid holdings of another financial institution. An entity holding significant non-performing assets will sell these holdings at market value to a bad bank. By transferring such assets to the bad bank, the parent institution can clean up its balance sheet—though it will still be forced to write off it.

National Asset Reconstruction Company Limited (NARCL)

Known as a one-stop solution to India’s growing bad debt menace, NARCL was incorporated on 7 July with an authorized capital of Rs 100 crore and classified as a “Central Government Company”. As shown by the ROC filing.

The primary advantage of NARCL would be in its ability to collect bad loans. Typically, when an ARC buys such loans from a bank, it is not always possible to buy the lenders’ total exposure to the borrower. This leads to delay in decision making and subsequently in the recovery of bad loans.

22 bad loan accounts worth Rs 89,000 crore to transfer to NARCL

Initially, state-run banks will transfer 22 bad loan accounts worth Rs 89,000 crore to NARCL. A total of Rs 2 lakh crore of bad loans is likely to be transferred in installments. As announced in the FY 2021-22 budget, NARCL will have bad debt accounts of Rs 500 crore or more, which will include an asset reconstruction company and an asset management company (AMC), which will manage and recover idle assets. The AMC is yet to be formed.

Purpose of setting up the Bad Bank

The setting up of the bad bank is part of the government’s efforts to clean up India’s financial system, which sits on one of the largest piles of bad assets in the world. Transfer of sour loans to NARCL will allow banks to cut their losses and renew lending. Now next step is to obtain approval from the Reserve Bank of India to function as an ARC.

Spain Bad Bank Case (2012)

Similar action was taken in the Spain Bad Bank case in 2012 when the Spanish Government gave banks powers to the Fund for the Orderly Restructuring of the Bank Sector (FROB) to pass toxic assets to a financial institution whose role is to remove risky assets from banks’ balance sheets and sell off the assets on profit over a period of 15 years.