In January 2022, Dinesh Khara, the Chairman of the State Bank of India announced that the National Asset Reconstruction Company (“NARCL”) has received all approvals to commence its operations. NARCL is what is colloquially known as a bad bank, formed to acquire illiquid and risky assets, such as bad debt, from distressed financial institutions. NARCL is a state-owned bank that will receive assistance from India Debt Resolution Company Ltd, which is majority-owned by private banks, by way of an exclusive arrangement on a principal-agent basis with final approvals from NARCL as the principal. Thirty-eight accounts have already been earmarked to transfer to NARCL. It was planned that 15 distressed assets would be transferred to NARCL by the end of March 2022. However due diligence, procedural and valuation issues proved to take longer than expected and these transfers are still to take place.   On March 10, 2022 ICICI Bank signed an agreement to invest in NARCL, acquiring 5% equity in NARCL. Public sector banks will maintain a 51% ownership in NARCL.

India recorded a ratio of gross non-performing assets to total advances over 8% in the 2020 fiscal year and 7.5% as of September 2020. India’s state owned banks account for more than 60% of the bad debt, although the State Bank of India, Bank of Baroda and Punjab National Bank each reported declines in non-performing loans in the last quarter of 2021. The approval of NARCL will be a welcomed move for the banks, as the proceeds from the sale of the bad assets will help them to further recoup some of the money they have lent.

Lessons from around the world

India is the latest in the list of countries who have formed bad banks to look to clean up non-performing assets. In response to the Asian financial crisis, China set up bad banks for each of its big four state-owned banks with the intention that they would acquire non-performing loans from those banks. The goal was to resolve the non-performing loans within 10 years, however in 2009 their tenure was extended indefinitely. Although India’s model will not be based on that of China, there are clearly lessons to be learnt. An important take away is that NARCL should have finite tenure and a clear and specific mandate that is not altered. In contrast, the China Huarong Asset Management Co. Ltd. bank in China extended its tenure and broadened its mandate transforming into an investment bank and it has been argued that the change in timeline of the bank has led to financial instability.

We have learned from the Resolution Trust Corporation in the United States and Securum in Sweden that by sticking to mandates and setting timelines, bad banks can be successful. In the US and Sweden the bad banks were wound up within their predicated lifespans. Sweden’s was dissolved and had disposed of 98% of its assets. Similarly, here in the UK, UK Asset Resolution (“UKAR”) was created in response to the financial crisis and managed the assets of Northern Rock and Bradford & Bingley. Like the US and Sweden, UKAR was focused on meeting its 2021 deadline and therefore by 2019 it had fully repaid the government loans given to the companies and sold the companies together with their assets in 2021.  In Ireland, the National Asset Management Agency (“NAMA”) was set up to take over the Irish bank’s property debts after the financial crisis. NAMA was originally due to be wound up in 2021, however in 2019, like China Huarong Asset Management Co. Ltd, the deadline was extended, but only until 2025. Paschal Donohoe, the Minister of Finance in Ireland, explained that this was to allow NAMA to deal with a small number of remaining loans. It has been indicated that when NAMA is wound up it will return a surplus on its activities as it has made a profit each year since 2011, perhaps suggesting that extending deadlines is not always a cause for concern.

Looking to the future

The success of NARCL, as with other bad banks, is a combination of a variety of factors.  First, such an institution needs political will and backing from government. Support from political leaders provides the vision and incentive for bad banks to acquire distressed debt. This has to come from the top-down, governmentally speaking.  Further, the process for take-on and divestment of such debt must be clear and streamlined, which acts as a further factor to drive action by regulators and others to encourage action on bad debt. A final factor is a careful use of private sector expertise in well-developed financial markets who are able to acquire bad debt. In this respect, the agreement of ICICI Bank to acquire 5% equity in NARCL is a positive sign.

NARCL’s creation is undoubtedly a step in the right direction for the future of the Indian financial markets in respect of bad debt.  It provides a key opportunity for Indian banks (especially state-owned banks) to sell distressed loans and improve their balance sheets. If India can closely follow the success of other bad banks around the world, this could prove to be a seminal moment for Indian debt markets.

The Reed Smith team have advised a variety seller, purchasers, borrowers and financiers in respect of distressed debt transactions and debt restructurings. If you are interested in learning more about Reed Smith’s India finance capabilities, please visit our India page or contact Gautam Bhattacharyya, Sarah Caldwell or Nathan Menon.