Government-owned bad bank is more capital efficient: Report

Amid confusing reports about the control of the proposed bad bank, a brokerage has called for government ownership, saying state-funding is more capital efficient apart from speeding up implementation and also lowering the credit cost/loss for the banks.

The government owning the proposed bad bank will not only be more capital efficient but also not impact the fiscal numbers, as otherwise, it will have to keep on recapitalising the state-owned lenders as they will be the biggest beneficiaries of the proposed bad bank, Bank of America Securities India said in a report.

Again, such a set-up can lower the credit charge on banks to a fifth in the worst-case scenario from the 100 per cent now, the report added.

As of March 2020, the net non-performing loans of banks stood at 2.8 per cent or Rs 2,89,500 crore, which is 1.3 per cent of the GDP, according to the report.

This will go up considerably 13.5 per cent by this September, a two-decade high, given the impact of the pandemic on the companies and banks, according to the Reserve Bank of India.

In January, a stress test by the central bank showed that public sector banks' gross NPAs might rise from 9.7 per cent in September 2020 to 16.2 per cent in September 2021, while private banks' from 4.6 per cent to 7.9 per cent, and foreign banks from 2.5 per cent to 5.4 per cent, taking the system-wide bad loans to 13.5 per cent by September this year.

The given understanding is that the proposed asset reconstruction company or ARC will be funded by state-owned banks/FIs.

According to the report, the proposed ARC taking over the bad loans of banks presents an opportunity for improving asset quality when real lending rates are falling.

But, the question is who will fund it? If state-run banks/FIs fund it the ARC will largely take over their bad loans, which was 2.8 per cent in March 2020. In this scenario, banks would then transfer their NPAs against security receipts issued by the ARC, it said.

But the house economists at the brokerage feel that a fully government-funded ARC will not only be faster to set up but may also be more capital efficient.

More importantly, the capital charge on the banks may come down to 0-20 per cent from 100 per cent now if these security receipts are issued by a fully-owned government company, which will be effectively guaranteed by the state.

On the fiscal side, this will not impact as anyway the government has to ultimately recapitalise banks, and so the potential fiscal impact is similar and it can easily draw down the RBI's revaluation reserves to recapitalise banks in a fiscal-neutral and liquidity-neutral transaction, the report said.

State funding may be faster and more capital efficient, it added.

The capital requirement of the ARC will depend on whether it is asked to maintain a CRAR of 9 per cent of RWA as applied to banks or 15 per cent as applied to NBFCs.

If the government provides equity as it will have to anyway recapitalise the write-offs either as the owner of the ARC or the owner of the state-run banks. Also, it is not clear if bank balance sheets can bear the hit of delayed recovery.

In any case, the government will end up implicitly guaranteeing recapitalisation of PSBs at the least.