In line with the announcement in the Budget 2021-22, a National Asset Reconstruction Company Ltd (NARCL), popularly known as a bad bank, has been incorporated. Leading public sector and private sector banks have been roped in as equity holders and the proposed NARCL will start operating after obtaining registration as an ARC by the RBI. The NARCL has started with a big bang, with a huge capital base estimated ultimately to be around ₹6000-₹7000 crore, and an aggregated approach by all banks for sale of large ticket loans to NARCL, presently covering loans with outstanding amount above ₹500 crores, aiming to acquire a target portfolio about ₹2 lac crores. Expectations are running high on the new structure which is to be complemented with an Asset Management Company (AMC). So far so good. The NARCL will issue Security Receipts (SRs) to the banks as purchase consideration, which is a typical transaction structure in an ARC deal. The SRs are proposed to be guaranteed by the government, reportedly to an extent of ₹31,000 crore.
Let us analyse what this government guarantee is all about. It guarantees the SR holders that even if the NARCL fails to redeem the SRs i.e., fails to collect the amount due from defaulting borrowers as estimated and priced at the time of acquisition, the shortfall will be paid by the government from the public exchequer to the SR holder having the beneficial interest.
This is no different than playing blind in a game of cards. The government is not involved with the selection and pricing of assets, and has no demonstrated track record of performance of NARCL, which, anyway, has been formed only recently. Yet, the government steps in to guarantee performance of the NARCL, which is not a public company, to realise the price NARCL has paid without the government being part of the process of price discovery mechanism. Government has an arm’s length distance from the issue, the issuer, and yet steps in with financial commitment underwriting the unknown.
What is more worrisome is that these SRs are freely trade-able and transferable. Foreign Portfolio Investors (FPIs) are coming in a big way in the SR market. In the last two years, between 2018-20, FPIs have increased their SR holding by ₹9861 crore against banks’ incremental SR holding of ₹5635 crore. FPIs will be more than happy to invest in a paper guaranteed by the sovereign. On the positive side, it will help market liquidity. On the flip side, FPIs may drag the government for non-redemption of SRs, which could have severe repercussions.
There are already 28 ARCs in the market. Giving government guarantee to a 29th ARCs will distort the level playing field and encourage monopoly and restrictive practice. Even now, some of the ARCs are owned by public sector banks only and the government has never bothered to extend this discretionary support. Besides, the government guarantee for a non-government entity rests with the unacceptable logic of private gain and public loss, as the government guarantees downside risk, while there is no mention anywhere of an upside on SR redemption being shared with the government.
In some countries, and mostly during a crisis ridden economy, the government has created necessary structure and framework and has used the government-guaranteed bonds as an instrument for NPA clean up. The context was different. The idea of a government guarantee has been copied and pasted, without applying any mind in the Indian context, and without adequate thoughts into its possible ramifications.
Views are personal. The author is a public policy columnist.
