India’s Bad Bank Experiment: Can NARCL and IDRCL Revive Financial Stability?

India’s Bad Bank Experiment: Can NARCL and IDRCL Revive Financial Stability?

India’s banking sector has long wrestled with an overwhelming burden of non-performing assets (NPAs). As of September 30, 2024, the total Non-Performing Assets (NPAs) in India, including loans that have been written off, is estimated to be over ₹12.80 lakh crore (or ₹12.80 trillion). Public Sector Banks (PSBs), which dominate 70% of the sector, were disproportionately affected, threatening the stability of the financial ecosystem. In response, the government introduced the National Asset Reconstruction Company Limited (NARCL) and the India Debt Resolution Company Limited (IDRCL)—a two-pronged approach to address stressed assets and restore credit flow.

However, while this initiative shows promise, its progress has been mired in operational inefficiencies, legal hurdles, and unresolved challenges. This article dives into the evolution, performance, and future of India’s bad bank experiment, with comparisons to global models and a critical look at its implementation.

The Genesis of a Bad Bank: Addressing the NPA Crisis

Understanding the Problem

India’s NPA crisis stems from an aggressive lending spree in the mid-2000s, exacerbated by economic slowdowns and inadequate credit monitoring. By 2018, gross NPAs had reached a staggering 11.2% of total advances, among the highest globally. Traditional recovery mechanisms, including the Insolvency and Bankruptcy Code (IBC) and SARFAESI Act, struggled to resolve large-value NPAs effectively, creating the need for an alternate resolution mechanism.

The Bad Bank Model

Announced in Budget 2021, the NARCL-IDRCL structure was designed to tackle NPAs exceeding ₹500 crore.

• NARCL, primarily owned by PSBs, acquires stressed assets, offloading them from banks’ balance sheets.
• IDRCL, with majority private-sector ownership, focuses on recovering value from these assets through restructuring or liquidation.

The government provided a ₹30,600 crore guarantee for Security Receipts (SRs) issued by NARCL, ensuring minimal risk for participating banks. This dual-entity model draws from international experiences, including Securum (Sweden), Danaharta (Malaysia), and TARP (USA), but tailors the approach to India’s complex financial and legal landscape.

Progress and Key Milestones: A Mixed Bag

Performance Metrics

NARCL has acquired ₹62,000 crore worth of stressed assets as of 2024, with resolution plans approved for accounts worth ₹33,000 crore. Major cases include Jaypee Infrastructure, Meenakshi Energy, and Rainbow Papers. Additionally, NARCL has lined up assets worth ₹1.25 lakh crore for acquisition, with due diligence underway for another ₹40,000 crore.

However, between January and November 2023, acquisitions totaled ₹11,617 crore but recovered a mere ₹16.64 crore reflecting significant underperformance relative to targets.

As of September 2024, the cumulative status of Non-Performing Assets (NPAs) in India reflects significant improvements in the banking sector:

• Gross NPA Ratio: The gross non-performing asset (GNPA) ratio for scheduled commercial banks (SCBs) has decreased to 3.12% as of September 30, 2024, down from 3.09% earlier in the year. This marks a notable decline from previous years and indicates a positive trend in asset quality
• Public Sector Banks (PSBs): The gross NPAs of public sector banks are reported to be approximately ₹3.16 trillion, which constitutes about 3.09% of their outstanding loans
• Private Sector Banks: In contrast, private sector banks have a lower GNPA ratio of 1.86%, with gross NPAs amounting to ₹1.34 trillion as of the same date
• Future Projections: According to stress tests conducted by the Reserve Bank of India (RBI), the GNPA ratio may improve further to around 2.5% by March 2025, indicating ongoing efforts to stabilize and strengthen the banking sector's financial health

The year-on-year (YoY) loan write-off data for Indian banks shows a notable decline in the financial year 2023-24 compared to the previous years:

• FY24: Indian banks wrote off loans totaling ₹1.70 trillion (or ₹1.7 lakh crore), marking a decrease of 18.2% from the previous fiscal year.
• FY23: The total write-offs were ₹2.08 trillion (or ₹2.08 lakh crore).
• FY22: The amount written off was approximately ₹1.75 trillion (or ₹1.75 lakh crore).
• FY21: Banks wrote off around ₹2.02 trillion (or ₹2.02 lakh crore).
• FY20: The peak write-off occurred at about ₹2.34 trillion (or ₹2.34 lakh crore) following an asset quality review initiated by the Reserve Bank of India.

Challenges in Implementation

1. Valuation Disputes: Disagreements between banks and NARCL over pricing have delayed asset transfers.
2. Litigation Overhang: Over half of the identified assets remain embroiled in legal battles, stalling the resolution process.
3. Operational Disconnect: The separate roles of NARCL and IDRCL have sometimes led to fragmented decision-making, reducing overall efficiency.

Global Lessons

• Sweden’s Securum resolved toxic assets within five years by centralizing authority and maintaining a clear timeline.
• Malaysia’s Danaharta leveraged special judicial provisions for expedited asset recovery during the Asian financial crisis.
• TARP in the US created a robust secondary market for distressed assets, improving liquidity and boosting investor confidence.

India’s fragmented ecosystem and slower judicial processes highlight the need for more aggressive adaptations.

Opportunities for Technological Integration

Globally, bad banks have increasingly relied on advanced technologies to enhance asset recovery. India’s bad bank, however, has been slow to adopt these innovations.

• AI-Driven Analytics: Predictive models could identify high-recovery assets and optimize resolution strategies.
• Blockchain Transparency: A blockchain-based system for tracking asset transfers could ensure tamper-proof records, mitigating disputes.
• Automated Due Diligence: Digitizing asset evaluations could significantly reduce acquisition timelines.

Case in Point: South Korea leveraged blockchain to create transparent asset records, bolstering stakeholder confidence—a move India could emulate to expedite resolutions.

Synergy with the IBC: Bridging the Gaps

The NARCL-IDRCL model is intended to complement the Insolvency and Bankruptcy Code (IBC) by offering a centralized approach to asset recovery. While the IBC addresses insolvency, NARCL focuses on recovering value from distressed assets acquired from multiple banks, reducing inter-lender disputes.

However, delays in NARCL’s processes often undermine these potential synergies. Developing a stronger collaboration framework with IBC mechanisms is essential for improving recovery timelines and outcomes.

The Road Ahead: Opportunities and Risks

Opportunities

1. Expanding Asset Pipeline: NARCL plans to acquire ₹2 trillion in NPAs by FY26, supported by increased private-sector participation.
2. Secondary Market Development: Building a liquid market for SRs could attract institutional investors, improving overall recovery rates.
3. Policy Support: Expedited regulatory approvals and policy incentives could help overcome current bottlenecks.

Risks

1. Execution Delays: Persistent delays in asset transfers risk eroding market confidence in the bad bank model.
2. Moral Hazard: The availability of a bad bank might encourage riskier lending practices among banks, undermining financial discipline.
3. Governance Concerns: Political interference in decision-making could compromise IDRCL’s operational autonomy.

Conclusion: Balancing Potential and Execution

The NARCL-IDRCL model has undoubtedly made progress in addressing India’s NPA crisis, but it remains a work in progress. While it holds promise for transforming the country’s financial landscape, success will hinge on bridging operational gaps, leveraging technology, and fostering collaboration between stakeholders.

India’s bad bank experiment is not just a test of financial engineering; it’s a bet on the resilience of its institutions. Whether it succeeds or falls short will shape the narrative of India’s economic recovery for years to come.