Lesson from China on bad banks

Context: To address stressed assets [nonperforming loans (NPLs), a bad bank must have a fixed term and a narrow mandate with clear aims. 
About Bad Banks

• A ‘bad bank’ is designated financial institutions that purchase and resolve nonperforming assets (NPAs) from banks and help banks to help clear their balance sheets.  
• NARCL- National Asset Reconstruction Company Ltd, the proposed bad bank for taking over stressed assets of Banks, was announced in the Budget for 2021-22. 

Lesson for India from China’s bad banks 

1. First, Bad banks should have a finite tenure – The bad bank should resolve these bad assets within a fixed period of time.  
2. Second, Bad banks should have narrow mandate with clearly defined goals and clear resolution strategy to resolve NPAs. 
3. Third, Policymakers must ensure that the NARCL’s establishment has no influence on RBI’s initiative to reduce bank holding in security receipts (SRs). 
4. Forth, NPAs resolution should take place through a market mechanism and not through a multitude of bad banks. 

The regulatory arbitrage between ARCs and AIFs must stop with the establishment of NARCL as a centralized bad bank. 

• AIFs should be allowed to purchase bad loans directly from banks and have enforcement rights under the SARFAESI Act. 
• ARCs should be allowed to purchase stressed assets from mutual funds, insurance companies, bond investors and ECB lenders.  
• ARC trusts should be allowed to infuse fresh equity in distressed companies, within IBC or outside of it. 
• The manager/sponsor of ARCs shall maintain the same level of interest as AIFs, i.e., at least 2.5 percent in each scheme or Rs 5 crore, whichever is lower. 

Road Ahead

• The policymaker should learn from China’s mistake and should limit the mandate and tenure of NARCL while facilitating market-based mechanisms for bad loan resolution in a steady state.