"Bad bank", "Asset Reconstruction Companies (ARCs)" and "Non Performing Assets (NPA)"

Banks have finalised plans to transfer 15 Non-Performing Asset (NPA) accounts worth Rs 50,000 crore to the National Asset Reconstruction Company Ltd. (NARCL), or the "bad bank" set up to help resolve the stress by the end of this financial year.

A total of 38 accounts aggregating to Rs 82,845 crore have been identified for transfer to NARCL, however the transfer will happen in a phased manner.

Initially, it was estimated that Rs 2 lakh crore of bad loans would be transferred to the bad bank but since some accounts have been resolved, the figure has come down to about Rs 1.5 lakh crore.

The Reserve Bank of India, being the regulator of Asset Reconstruction Companies (ARCs), has already prescribed a regulatory framework for the functioning of ARCs and there are well-laid norms for transfer of stressed assets by banks and non-banking finance companies to ARCs.


All requisite approvals, including from the RBI, for setting up National Asset Reconstruction Company Ltd. (NARCL) and the India Debt Resolution Company Ltd. (IDRCL) have now been received and that both companies are ready to commence business.

The broad features of the arrangement are that NARCL will acquire and aggregate the identified NPA accounts from the banks, while IDRCL, under the exclusive arrangement will handle the debt resolution process.

The final approval and ownership for the resolution shall lie with NARCL as the principal.

This arrangement will also be in full conformity with the provisions of the SARFAESI Act as well as outsourcing guidelines of the RBI.

Public sector banks have taken a majority stake (51 %) in NARCL, while private sector banks would hold majority (51 %) in IDRCL.

NARCL has the mandate to acquire the identified assets on a 15:85, cash: secured receipt (SR) structure. It will pay 15% of the agreed price in cash and the remaining 85% will be in the form of "Security Receipts".

The SRs will be issued in favour of lenders transferring the assets, when the assets are sold, the commercial banks will be paid back the rest (85 %).

These SRs will be secured by a Government of India guarantee for a period of five years on their face value.

Both the companies have their respective boards in place.

In no way will it jeopardise the activity of existing ARCs.

What is a "Bad bank" ?

A bad bank is an asset reconstruction company (ARC) or an asset management company that takes over the bad loans of commercial banks, manages them and finally recovers the money over a period of time.

The bad bank is not involved in lending and taking deposits, but helps commercial banks clean up their balance sheets and resolve bad loans.

The takeover of bad loans is normally below the book value of the loan and the bad bank tries to recover as much as possible subsequently.

A large volume of non-performing assets usually make it difficult for the bank to raise capital, for example through sales of bonds. In these circumstances, the bank may wish to segregate its "good" assets from its "bad" assets through the creation of a bad bank.

By transferring such assets to the bad bank, the original institution may clear its balance sheet, to allow investors to assess the bank's financial health with greater certainty.

The approach allows good banks to focus on their core business of lending while the bad bank can specialize in maximizing value from the high risk assets.

According to RBI - It's not really a bad bank but an ARC-type entity set up to take over the stressed assets from the books of public sector banks and try to resolve them like any other ARC.

Asset Reconstruction Company (ARCs)

An Asset Reconstruction Company is a specialized financial institution that buys the NPAs or bad assets from banks and financial institutions so that the latter can clean up their balance sheets.

In the Budget 2021-22, Asset Reconstruction Company (ARC) have been proposed to be set up by state-owned and private sector banks, and there will be no equity contribution from the government.

This is being considered as the government's version of a bad bank.

Rather than going after the defaulters and wasting time and effort, banks can sell the bad assets to the ARCs at a mutually agreed value and can concentrate in normal banking activities.

The Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest (SARFAESI) Act, 2002 provides the legal basis for the setting up of ARCs in India.

An ARC should have a minimum net owned fund of Rs. 100 crore, and also have to maintain a capital adequacy ratio of 15% of its risk weighted assets.

What are Non Performing Assets (NPA) ?

Non Performing Assets (NPA) is any asset (loan or lease) of a bank which is not producing any income.

Banks usually classify as nonperforming assets any commercial loans which are more than 90 days overdue and any consumer loans which are more than 180 days overdue.

For agricultural loans, if the interest and/or the installment or principal remains overdue for two harvest seasons, it is declared as NPAs. But, this period should not exceed two years.

1. Sub-standard: When the NPAs have aged <= 12 months.

2. Doubtful: When the NPAs have aged > 12 months.

3. Loss assets: When the bank or its auditors have identified the loss, but it has not been written off.

KV Kamath committee

The RBI had formed a five member committee under the chairmanship of former ICICI Bank Chief Executive KV Kamath to make recommendations on the financial parameters to be considered in the restructuring of loans impacted by the Covid 19 pandemic.

Indian Banks' Association (IBA)

Indian Banks' Association (IBA) was formed on 26 September 1946 as an association of Indian banks and financial institutions based in Mumbai. With an initial membership representing 22 banks in India in 1946, IBA currently represents 247 banking companies operating in India.

It was formed for development, coordination and strengthening of Indian banking, and assist the member banks in various ways including implementation of new systems and adoption of standards among the members.

IBA is neither a governmental entity nor a regulatory authority, and it is not subject to the Right to Information Act, 2005.

Indian Banks' Association is managed by a managing committee, and the current managing committee consists of one chairman, 3 deputy chairmen, 1 honorary secretary and 26 members.

The Indian Banks' Association (IBA) has begun identifying bad loans which can be transferred to the Centre's proposed bad bank.

The IBA has written to banks asking them for a list of all bad loans worth Rs 500 crore and above to "identify magnitude of the problem" and "get clarity over initial capital required for the entity".