India may face hurdles in creating a bad bank

bad bankThe banking regulator and the government are unlikely to accept two key proposals that the bankers’ lobby group has made, which can affect creating a bad bank.

For bad banks, the Indian Bankers’ Association wants to transfer accounts where fraudulent activities have been detected to the new entity that will hold their risky assets. Bad loans will be sold at book value to the asset reconstruction company, as proposed.

Fraud-hit accounts could be considered on a case-to-case basis, with approval from the regulator, to sell to the band bank as per the proposal submitted to the government and the Reserve Bank of India. All inquiries relating to fraud investigation have to be dealt with by the lender who sells these loans.

Banks cannot sell bad loans that have originated fraudulently or have been classified as a fraud as on the date of a planned sale because the current rules don’t allow the sale of such loans, the RBI had said in an April 2011 communication to all scheduled commercial banks.

Banks have a concept to transfer Rs 70,000 crore of bad assets to the planned ARC. Frauds worth Rs 1.43 lakh crore were reported by banking and financial institutions as per data with the finance ministry, between April and December 2019.

Transfer of assets to the bad bank on the book value net of minimum regulatory provisions is another bone of contention. This would avoid a time-consuming valuation process and due diligence. But, even ARCs don’t buy bad assets from banks at book value.

“Banks have taken haircuts ranging from 20% to 90% in every bad bank sale,  then how can this sale happen at book value without determining the true valuation of the underlying asset and its recovery potential,” questioned the CEO of an ARC, whereas speaking on the condition of anonymity.

Asset values have been inflated in bank books, as per the data in RBI books. When an ARC bought a loan from a bank, the recovery rate was more than 40% in 10 of the past 15 years while in 2009 and 2010, it was more than 90%. For the 15-year period between 2004 and 2019, the average recovery rate had varied between 2.4% and 21.5% of the book value.

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