The bad bank proposal and method of value determination

PM Narendra D. Modi recently commended the part of the private sector in national development. Some were recalled of his 2014 appeal for “minimum charge, maximum governance”. The budget release of a ‘bad bank’ gives a valuable lens to analyse how eloquence plays out in policy creation. But first, a short history of India’s distressed debt businesses, covering both insolvency law and the market for NPAs (non-performing assets).

India implemented a bankruptcy law, the Insolvency and Bankruptcy Code(IBC), as late as 2016. Asset Reconstruction Companies (ARCs) employed in the recovery of NPAs were designed earlier through the SARFESI Act in 2002. The NPA market intended to move bad debt off the balance sheets of banks and commercially relevant values. Allowing ARCs to partially pay for NPAs in bonds allowed banks to use buyer firms’ revival forecasts to improve deal values.

The bad bank proposal and method of value determination

However, a balance was struck, as high-security securitisation, levels transfer risk out of banks’ books. From 2002 to 2016, businesses had a high proportion of security. Indeed, over 2002-2007, with cash balances as low as 7%, ARCs could earn a positive net gain solely based on administration fees, without any value appreciation by way of securitisation or asset restoration. In 2006, the RBI conditioned a minimum cash proportion of just 5%.

Why would these deals be agreeable to banks? Among a weak bankruptcy scene, banks had to resolve for low dealings. They would prefer to hold contracts at such values to hope for high future returns rather than accept cash.

At such high levels of cash, the trade becomes unviable for all but the most exceptional assets. Even then, that would happen only if ARCs can collaborate with global funds that obtain capital at rock-bottom interest rates. An evaluation agency report states that in 2018-19, such investors’ holdings in newly-issued security receipts rose sharply.



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