NPA Resolution and Bad Bank

The success of the newly announced “bad bank” or the National Asset Reconstruction Company Ltd will depend on its ability to maximise recovery with minimum costs. Three major conditions are critical for the NARCL to succeed. First, clarity in identification of non-performing loans. Second, a high growth trajectory in the economy. And, third, preventive measures to stop any new loan turning into a non-performing asset too soon.

The article is drawn from a research project “Performance of India’s Banking Sector: A Critical Focus on NPAs,” funded by the Indian Council of Social Science Research.

The finance minister has recently announced the creation of the National Asset Reconstruction Company Ltd (NARCL), which will play an instrumental role in the resolution of non-performing assets (NPAs). As per the announcement, large NPAs of banks will be transferred to the NARCL. It will help clean the balance sheets of the banks and reduce stress. The idea behind the creation of this institution is to help the banks focus more on lending activities rather investing a significant amount of time and resources in dealing with failed loans.

Given the severity of the current NPA crisis, it important that the NPA resolution takes place in a timely manner to limit its negative impact on the banks and the economy. Any NPA resolution approach must be built on two critical aspects: (i) policies or measures that are preventive in nature so that the NPA crisis does not occur at this scale in the future, and (ii) policy or a resolution mechanism for existing accumulated NPAs, so that its negative impact can be minimised. The announcement with respect to the creation of a “bad bank” or “National Asset Reconstruction Company” is focused on the latter aspect. This is driven by the understanding that it is important to clean up the balance sheet of the banks by eliminating or reducing bad loans. However, it is equally important to undertake policy measures that aims at the former aspect so that it will prevent the occurrence of additional NPAs. The policy measures that will be required to address this aspect are structural in nature. It is important that both the above aspects are addressed through various policy measures for a robust NPA resolution or management mechanism.